United States

Environmental Protection

Agency

Office of Municipal EPA 430/9-86-001

Pollution Control (WH-595) September 1986

Municipal Facilities Division

Washington DC 20460

&EPA Touching All The Bases

A Financial Management

Handbook For Your

Wastewater Treatment Project
I

United States

Environmental Protection Agency

Touching All The Bases:

A Financial Management Handbook

For Your Wastewater Treatment Project

U.S. Environmental Protection Agency

Office of Municipal Pollution Control

Municipal Facilities Division (WH-595)

Washington, D.C.

September 1986

II
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11

This report has been reviewed by the Environmental Protection

Agency (EPA) and approved for publication. The views,

opinions, conclusions, and recommendations herein do not

necessarily reflect those of the EPA. Mention of trade names or

commercial products does not constitute endorsement or

recommendation for use.

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Foreword

This handbook, developed for EPA's Office of Municipal

Pollution Control, explains how to manage your community's

finances during the planning and construction of a wastewater

treatment system. Financial management during this period is a

very complex and exacting task, but it is a task that must be

diligently performed in order to protect the considerable

investment you are making in the treatment system. Because

your ability to manage events depends directly on your ability to

anticipate them, this document devotes appropriate attention to

the key events which must precede the commencement of

construction as well as those activities which you must perform

during actual construction and in the period immediately

following.

This handbook is only intended to provide the reader with a

general background of a very complex subject, spanning, as it

does, the planning, design, and construction stages. EPA has

developed various other publications dealing with municipal

finance and treatment technologies that are applicable to specific

stages of treatment plant development and operation. These

publications should be read by those directly responsible for the

success of the treatment project. Two of the publications relating

to finance are listed in the bibliography (Financial Capability

Guidebook and User Charge Guidance Manual), along with

publications dealing with other wastewater treatment plant

topics. Information on the Guidebook and Guidance Manual,

plus information on other financial management publications,

can be found in the current edition of the Financial Management

Publications Update for Wastewater Treatment Plants. The

Update and most other EPA publications dealing with financial

management are available from the Environmental Quality

Instructional Resource Center, 1200 Chambers Road, Room 310,

Columbus, Ohio 43212. (Telephone: (614) 422-6717).

This publication was written by James c. Joseph, Paul L. Shinn,

and Joseph T. Kelley of the Government Finance Research

Center (GFRC) of the Government Finance Officers Association

(GFOA). Additional assistance was provided by John Peterson

and Arthur Gitajn, also of GFRC. The project was managed for

EPA by Brian C. Rourke.

Note that the statements, conclusions, and recommendations

contained herein should not be construed as setting forth any

legal or regulatory requirements beyond those set forth in the

Clean Water Act, as amended. (33 U.S.c. 1251 et seq.) and

EPA's construction grants regulation, 40 CFR Part 35; general

grant regulation 40 CFR Part 30; and grant procurement

regulation 40 CFR Part 33.

III

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Table of Contents

********

~.'.. ./k'

Chapter I. Introduction--Taking The Field

Why this handbook was written; what's in it; how it's organized.

********

Chapter II. The Financial Planning Phase--Getting on Base

Understanding the Ground Rules

Everything you should know before you do anything. (If it's not here, at

least you'll know where to look.)

• Federal Grant Eligibility: Is your town eligible; who should you ask?

• Federal Laws and Regulations: which ones apply to your town If it

receives a Federal grant? Which ones apply even if it doesn't?

• State Laws and Regulations: Some typical requirements and how they

can affect your wastewater treatment project.

• Local Requirements: Has your town imposed additional requirements on

itself?

Capital Planning

How your treatment project will fit in with your town's long-range

financial plans.

• Facility Inventory and Project Identlfication: What do you have now

and what will you need in the future?

• Priority-Setting: Decisions on the future ofyour town are going to be

influenced by the Clean Water Act's requirements.

• Assessment ofFunding Sources: What to look for when deciding where

the money should come from.

5

5

7

v

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Table of Contents

VI

• Borrowing: Should your treatment project debt be supported by taxes

or revenues? Pros and cons of each.

• Capital Budgeting: The Capital Improvement Plan is connected to the

capital budget and to the operating budget.

Assembling Your Team

Who ya gonna call (on)?

Project Planning

• Estimating Capital Costs: Are the estimates reasonable? Do they

include ALL the costs? How can you tell?

• Estimating Operating Costs: Do these estimates seem less imposing than

the capital cost estimates? Look again: mistaken estimates here could be

nine times more costly than mistakes in the capital cost estimates.

• Preventing Costly Reexamination of Your Project: Review of

Guidelines for the Planning Phase.

Conclusion

********

Chapter III. The Pre-Construction Phase of Financial

Management--Moving to Second

Short-Term Financing

Bridging the gap to long-term financing

• Short-Term Financing Alternatives: The uses ofBANs and GANs.

• Arbitrage Earnings During Construction: How to reduce the debt

service on your short-term borrowing.

• Advantages of Shor,--Term Financing: But the risks involved make the

services of a financial advisor essential.

Designing the Bond Issue

What size? How long a term? Competitive sale or negotiated process?

Method of retiring the bonds? Call privileges? Indenture? Insurance?

The Construction Contract

What should you consider when hiring a contractor, when advertising for

and evaluating bids? Should your contract contain provisions for

retainage, performance bonds, change orders, and termination? Yes, and a

few others as well!

10

15

17

21

21

24

26

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Table of Contents The Project Budget

How to figure out where the money is coming from and where it's going.

The Cash-Flow Forecast

How to figure out when the money is coming and when it's going.

Planning the Operating Budget and User Charge System

Estimating first-year costs and developing the revenues to meet them.

Conclusion

********

Chapter IV. Financial Management During the Construction

Phase--Rounding Third

Establishing Accounting Systems

The more money you have to account for, the more important is your

accounting system: How should you account for grant-eligible and

ineligible costs? Who should assume the many accounting tasks? What are

the four most common accounting problems for communities receiving

grants?

Processing and Recording Transactions

When to record everything that needs recording.

Investing Construction Funds

Where to find a safe home for your construction funds and still have

money available to meet the expenses identzfied in the draw-down schedule.

Managing the Contract

Choosing the one person who will protect the community's interests.

Monitoring Project Progress

What sort offinancial reports should be made? By whom? To whom? How

often?

Conclusion

29

31

34

36

39

39

41

42

43

45

48

VB

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Table of Contents

V1ll

********

Chapter V. The Project Completion Phase--Crossing the Plate

Implementing the Revenue Plan and User Charge System

Public notification and citizen participation should precede actual

adoption of the rate system.

Selling Bonds

Timing is critical, so be sure to start the process at least three months

before closing.

• Marketing the Issue: Preparing the official statement, notice ofsale,

bid form, and indenture (tf necessary); getting a bond rating.

• Closing the Sale: Awarding the bids, printing the bonds, closing the

bond issue, and establishing payment mechanisms.

Preparing for the Grant Audit

What records will be needed?

Conclusion

********

Chapter VI. Conc1usion--The Post-Game Wrap-Up

Recapping the great moments!

Appendix A: Glossary

Appendix B: Bibliography

51

51

52

53

53

57

59

71

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List ofExhibits

Exhibit 1:' The Construction Process and the Financial

Management Process

...................................................... 3

Exhibit 2: Roles of Team Members By Activity

..................................................... 11

Exhibit 3: Matrix of Functions Performed in the

Planning Phase

.................................................. " .18

Exhibit 4: Construction Draw-Down and Interest

Earning Schedule

.....................................................23

Exhibit 5: The Bond Sale Process

.....................................................25

Exhibit 6: Project Budget

.....................................................30

Exhibit 7: Project Cash-Flow Forecast

.....................................................32

Exhibit 8: Summary of Cash Balances

.....................................................35

Exhibit 9: Matrix of Functions Performed in the

Pre-Construction Phase

.....................................................37

Exhibit 10: Budget Report

.....................................................46

Exhibit 11: Cash-Flow Report

.....................................................47

Exhibit 12: Matrix of Functions Performed in the

Construction Phase

.....................................................49

Exhibit 13: Matrix of Functions Performed in the

Project Completion Phase

.....................................................54

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A Series ofWorldly Tips and Traps

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TIP: A wastewater treatment faC11ity requires provision

for ongoing operating and maintenance expenses) which

are often higher than the annual debt service obligations.

Special care must be taken to evaluate the potential

operating budget impact ofany capital investment.

(Chapter II, p. 10)

TRAP: A community that leaves in-house

responsibilities to outside specialistsloses some ofits

decision-making power and thereby relinquishes control

ofthe project. (Chapter II, p. 13)

TIP: The selection ofthe wrong technology can be one

ofthe most expensive mistakes a community can make.

You must be sure that the technology being considered

is the most appropriate (and cost-effective) for its

purposes. Alternative treatment and collection

technologies should be careful1y considered) especially in

. smal1 communities. (Chapter II) p. 15)

TIP: The term ofthe bonds should never exceed the

expected useful life ofthe facility. Ifit does) you may

end up paying debt service on two bond issues for the

same purpose. With this rule in mind) you have some

flexibility in selecting a term that most closely matches

the desired cash-flow pattern. (Chapter III) p. 24)

TRAP: One common cause ofshortfal1s during

construction is overly optimistic budgeting.

Communities that have run out offunds in the

construction phase have often been guilty ofoptimistic

budgeting) particularly in these items:

- interest earnings during construction)

- proceeds from short-term financing)

- items eligible for EPA grant funding)

- costs ofissuing debt) and

- construction costs.

(Chapter III) p. 29)

TIP: It is important to forecast and track the account

balances for everyone ofthe accounts because you must

maintain a positive balance in each one. Ifthe

community overdraws the account for construction) it

will be barred from paying construction bills from other

accounts by legal and investor restrictions. It wil1 in

effect be unable to pay its contractor. (Chapter III) p. 31)
I I

TRAP: The five most common accounting problems for

communities receiving grants are:

- failure to separate eligible and ineligible costs;

- failure to segregate costs between different grants;

- failure to develop written procedures for grant

accounting;

- failure to justify and record Federal

reimbursements;

- failure to maintain documentation supporting

payment requests. (Chapter IV, p. 40)

TRAP: One common mistake made by communities

with construction projects is using separate bank

accounts to keep track ofdifferent types ofmoney. This

should be avoided at all costs and done only when note

or bond indentures require separate bank accounts to

secure the debt obligations. Multiple accounts are

expensive to maintain and to balance) and they also

promote accounting errors. (Chapter IV, p. 41)

TIP: In a falling interest rate environment) the interest

yields in an investment pool are generally higher than

those available through independent investing. This is

because the interest yield in the pool is determined in

part by securities that were purchased when rates were

high. (Chapter IV, p. 43)

TIP: It is a good practice to develop an updated cashflow forecast every month. This new forecast should

reflect the actual cash-flow up to the date ofthe forecast)

with a revised monthly forecast ofall sources and uses

for the remainder ofthe project. (Chapter IV, p. 48)

TIP: Long-term self-sufficiency ofthe treatment plant

can be ensured by writing the rate ordinance so that any

required rate increases are automatically built into the

operating budget approval process. (Chapter V, p. 52)

TIP: Since the time needed to complete a bond sale

varies with the type and complexity ofthe sale) the

length oftime needed should be determined well in

advance ofthe need to sell the bonds. You should time

the bond sale so that proceeds are available to payoff

any short-term financing and any costs ofconstruction

that will not be paid from cash or short-term financing.

(Chapter V, p. 52)

TIP: The financial advisor should solicit input from

potential underwriters to determine the need for a rating

on small issues. Ifyou have outstanding debt that has

been rated) all subsequent issues with the same security

should also be rated. Failure to request a rating ofa new

issue with the same security provisions as currentlyrated debt could result in the withdrawal ofthe existing

rating. (Chapter V, p. 52)

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CHAPTER I

Introduction:

taking

the

field

Building a new wastewater treatment plant is a major

undertaking even for America's largest cities. For

smaller jurisdictions, the construction project may well

be the largest single public works project ever

undertaken. Besides being costly, building a treatment

facility is both time-consuming and complex. Because of

all of these factors, wastewater facilities construction

requires special management efforts, particularly in the

realm of financial management.

It is easy to overlook the financial aspects of a

construction project, particularly in the planning stages.

When you contemplate building new facilities you tend

to concentrate your efforts on selecting an engineer,

designing the facility, purchasing land, hiring a

contractor, and watching the new plant rise from the

ground. Unfortunately, this approach often leads to

shortcomings in financial management, which can lead

to serious problems as the plant is being built and when

it becomes operational.

Finance should be a major consideration at every step of

the process of building or upgrading facilities, from

design through construction and completion. You must

make special efforts to secure both short-term and longterm financing; to determine the impact of the project

on operating revenues, expenses, and user fee levels; to

monitor all financial transactions relating to design and

construction; and to protect your community's financial

interest throughout the process.

Failure to establish and follow good financial

management practices can lead to serious problems that

often either delay completion of the facility or stop it

altogether. The pitfalls are many and varied. A few of

the more common problems are:

• building a project that is too costly for the

community;

• failing to verify that the contractor's bills reflect work

actually completed;

• allowing costs to exceed available funds;

• failing to maintain cash balances that are adequate to

pay project costs;

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• jeopardizing opportunities for Federal and State

grant funds by failing to maintain good records; and

• failing to make arrangements for workable long-term

project financing.

The purpose of this handbook is to help local

governments that anticipate building new treatment

facilities minimize the likelihood of falling into these

traps. It is aimed primarily at smaller governments that

are building their facilities with the assistance of a grant

from the U.S. Environmental Protection Agency (EPA),

but it can be of use to any jurisdiction that is

constructing a treatment plant, regardless of size or

funding sources.

This handbook concentrates mainly on the

considerations involved in securing and then managing

short-term and long-term financing for the construction

project. However, it is impossible to look at these topics

in isolation. Your community must also understand the

importance of engineering, planning, controlling and

reporting and how each of these tasks can be designed to

contribute to good financial management. Similarly,

management of finances during construction cannot be

explained without an understanding of what happens

both before construction begins and after it ends.

The handbook is organized chronologically, so that you

can walk through the entire process, from the early

planning stages through actual construction to

arrangement of long-term financing and the final audit

of the project. In Exhibit I, you will find an

approximate representation of how the financial

management functions discussed in this handbook relate

chronologically to the steps taken toward completion of

the treatment facility.

Like many examples in American life, the construction

financing process can be spoken about in terms of the

game of baseball. The handbook uses a trip around the

bases as a metaphor for the process; you can think of the

planning stage as getting you to first base, preconstruction getting you to second, construction moving

you around to third, and preparing for an audit and

closing the project as the trip home. This metaphor will

help you keep track of where you are in the process.

In addition to the text, the handbook includes graphic

representations of the major points of the financial

management process. Exhibits show how various types

of financing relate and how the processes begin and end.

Highlighted "tips" and "traps" give an idea of special

opportunities and problems to watch for during the

construction financing process. A glossary of financial

terms is included as an appendix to the handbook.

Terms that are defined in the glossary are highlighted in

bold print the first time they appear in the text.

This handbook is not intended to be your only source of

information on financing during construction. It is,

rather, an overview of the financial events that are

involved in the construction process and illustrates how

these events relate to the construction itself. By taking

this approach, the handbook promotes a broad

understanding of what to watch for in the process and

how best to manage the project financially. It is hoped

that this will help your community achieve its goal of

completing construction within budget and on time.

Additional sources of information can be found in the

bibliography.

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Exhibit1

• 1111111111111»

'1111111111111111111'

Financial planning

should occur during the

same time as facilities

planning for the WWT

project.

The pre-construction

phase of financial

management should

begin as soon as

planning is finished and

should be completed no

later than the time plant

design work is done.

The construction phase

of financial management occurs at roughly

the same time as the

construction of the

facility, though it is

wise to begin certain

tasks (establishing

accounting systems) in

the pre-construction

phase, if possible.

The completion phase

of financial management occurs during the

last part of plant

construction.

3

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CHAPTER II

The

financial

planning

phase:

• gettIng

on base

A structured, well-defined planning process can help

your community order its priorities and better respond

to the pressures associated with new capital projects.

In this way, you can evaluate your capital investments

and look at each individual project in the context of your

entire capital and operating program. Once you decide

to begin a capital project, you should establish the policy

and financial and legal bases for the project before

beginning the design phase.

This section describes a process for planning that will

help you put your wastewater treatment facility into the

broader perspective of your community's capital needs

as a whole. The first step in this process is to understand

the ground rules under which you will be operating. The

second step is to prepare a capital plan and budget,

which lists all construction in priority order and

determines the schedule and funding method for each.

The third step is to assemble a team of experts from

both the local government staff and outside consultants

to design the project, develop the financing plan, and

assure that it all works from the legal and administrative

points of view. The fourth step in the planning process

is to develop the plan for the project itself. This phase

includes design (engineering), detailed budgeting and

scheduling, and refining the financing plan. When this

planning process is complete, you can think of yourself

as having reached first base; much of the hard work is

behind you, and you have a much better chance of

scoring a run later in the inning.

UNDERSTANDING THE

GROUND RULES

Because local governments are responsible for their

taxpayers' money, it is not surprising that they face a

wide range of laws and regulations that direct their

actions. It is also reasonable to assume that many of

these laws will govern major construction projects

because of the large dollar amounts involved. The goal

of these constraints is to promote sound financial

management to assure that public funds are kept and

used wisely. Your community should therefore not

resent the level of regulation, but use it as a guide to

developing sound management systems.

It is important to read and understand applicable laws

and regulations early in the process to avert unexpected

5

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legal problems later. Wherever possible, this handbook

refers to specific legal requirements in the appropriate

sections. It is useful, however, to review all of these

requirements at this point, so that you may stop and

determine the legal constraints you will be facing before

continuing into the pre-construction phase.

Grant Eligibility

The U.S. Environmental Protection Agency (EPA)

currently awards grants to communities for the

construction of treatment facilities, generally for 55

percent of eligible costs. As soon as your community

identifies its wastewater treatment needs you should

determine whether your project will be eligible for an

EPA or a State grant. In most States, an agency is

delegated to work with communities to manage the

grants process. You should locate the appropriate agency

in your State to find answers to these questions:

• Is your project presently eligible for a grant?

• If not, how could your project become eligible?

• What is required for eligible projects to receive a

grant?

Federal Laws and Regulations

The Clean Water Act requires that your community

provide adequate levels of wastewater treatment prior to

discharge into rivers, streams, lakes, and other bodies of

water. You will have to address these clean water

standards whether or not you receive a construction

grant. This requirement will thus influence other

municipal decisions, especially those relating to your

capital improvement program. If a Federal grant is

provided, communities must also satisfy a number of

Federal requirements (summarized in the EPA

publication, Construction Grants-l985) as a condition

of such financial assistance. Those requirements that

relate to the financial management aspects of wastewater

plant construction are covered in detail in the

appropriate sections, but are summarized for planning

purposes here as well:

• Financial capability: EPA's Financial Capability

Policy requires that grant applicants demonstrate

their capability to finance and manage plant

construction and operation. EPA has prepared the

Financial Capability Guidebook to assist grantees

with this step. Financial capability analysis is a useful

planning tool because it assists the community in

determining all construction and operating costs, in

evaluating the level and impacts of user charges

necessary to support the facility, and in assessing the

community's ability to sell bonds to finance

construction. This process should be integrated into

the project planning phase so that the community

may identify at the earliest possible time any

problems with project impacts or financing.

• Financial management and record-keeping: EPA also

requires that grantees maintain a financial

management system that records and reports

accurately all grant-related financial activities and

controls the project budget. Chapters III and IV of

this handbook provide detailed information on

project accounting. EPA has also published the

Financial Management System Manual to provide

assistance in developing an accounting system.

• User charges: EPA requires that grantees establish

and maintain user charges throughout the useful life

of the facility at a level sufficient to offset costs of

operating and maintaining the facility and for

replacing components as necessary. This regulation

also requires that charges be in proportion to actual

use by each customer. See Chapter III for a

description of the user charge study process and 40

CFR 35.2140 for the complete requirement.

Additional guidance in developing a user charge

system is offered by EPA in the User Charge

Manual.

If your community sells notes or bonds, it will also be

subject to regulations issued by the U.S. Treasury

Department. These regulations specify steps you must

take to assure that interest on debt is tax-exempt, so

that you may take advantage of the lower interest

available in the municipal market. The regulations are

complex; your bond counsel and financial advisor should

work together to structure the financing to ensure that it

complies with all Treasury requirements and still meets

your needs to the greatest extent possible. (Note: This is

particularly important if changes are made to existing

tax legislation as part of the tax reform effort pending

before the current (1986) Congress.)

State Laws and Regulations

It is impossible to provide in this manual an exhaustive

list of all State laws that might govern the financial

management aspects of treatment facility construction.

The approach of this subsection is to give you a list of

typical State requirements so that you may identify and

comply with the specific laws of your State. Common

State requirements are:

• Budget laws: Most States require local governments

to prepare an annual budget. The treatment of

construction grants and project expenditures in a

budget varies somewhat. Ask your budget officer to

review State laws to determine how to budget for the

project. Remember that budgets often have long lead

times and that State budget laws need to be

addressed early in the process.

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* * * * * * * * * * * * * *

TIP: Remember that a construction project may have to

be budgeted in more than one annual budget ifit takes

more than one fiscal year to complete.

• Purchasing laws: States usually limit local

governments' freedom to purchase goods and

services. They typically require that contracts be

awarded on the basis of competitive bidding. Your

State may have very specific requirements on

preparing specifications, advertising the bid, and

deciding how to award the bid. Be sure to review

these laws to understand their impact on costs and

time requirements for the purchasing process.

**************

TRAP: Some States exempt contracts for certain

services (e.g., engineering, financial advisor, etc.) from

competitive bidding. Despite this authority, it is both

contrary to EPA regulations and a bad management

practice to select any professional advisor without some

level ofcompetition. (See 40 CFR Part 33.)

• Accounting and auditing: Some States specify how

local governments should keep their accounting

records. Also, if your community receives more than

$100,000 in federal funds during a fiscal year, Office

of Management and Budget (OMB) Circular A-128

requires that you obtain an audit of your records

each year. Your finance officer should be aware of

these limitations and should help set up a project

accounting system that both meets State law and

provides needed information about and control over

the project at hand. Note also that some States

require an annual audit that may include an audit of

how grant funds were handled; so your project may

be audited twice. Remember this when storing

records. (See 31 U.S.c. 7501 et seq.)

• Investing: States are sensitive to possible loss of

public funds through poor investment decisions,

especially in light of recent failures in the securities

markets. State laws govern how note and bond

proceeds may be invested. Your finance officer

should be very careful to follow these laws because of

the large amount of funds involved.

• Selling bonds: Every State limits to some degree a

community's ability to sell bonds. The most common

limitation is on the amount of general obligation

debt that may be issued. Other common State

requirements are that an election be held to approve

a bond issue, that bonds be sold competitively (with

advertising and disclosure requirements) and, in

some States, that a State agency approve the

structure of the bond issue prior to the sale. Some

States will provide bond guarantees or provide

partial payment of qualified debt service, which can

lower interest rates.

**************

TIP: Before beginning to plan this project, ask yourinhouse attorney and bond counsel to give you a Hst ofall

State requirements on bonding and what specific steps

you will have to take to comply. Also ask your financial

advisor to calculate whether you have capacity within

your debt limit to issue enough bonds to finance the

project.

Local Requirements

Local governments often impose limits on themselves in

city charters or ordinances. You should ask your

attorney to prepare a list of the applicable local

requirements, which might cover budgeting, the bond

issuance process, public input, and other processes. Be

sure to allow enough time and staff resources to meet

each of these requirements.

CAPITAL PLANNING

The financing arrangements for each facility, whether a

school, highway, or wastewater treatment plant, must be

considered within the context of a community's

comprehensive capital improvement program. The

capital improvement program represents a multi-year

plan (usually covering 5 years) of all spending for capital

projects, encompassing both necessary repair and

replacement of existing infrastructure and a reasonable

level of funding for facilities to accommodate growth.

The first year of the capital improvement program

becomes the community's capital budget. At that time,

a review of the entire capital improvement program

takes place, resulting in the addition and deletion of

projects and the extension of the plan another year into

the future. Appropriations for capital projects usually

extend beyond a single fiscal year. For this reason, a

government must coordinate its efforts to ensure that

past, present, and proposed commitments in the capital

improvement program can be funded with resources that

are expected to be available (current, projected, and

borrowed).

The importance of careful planning and priority-setting

within the capital improvement program cannot be

overstated. Too often governments reduce capital

appropriations in periods of fiscal stress, transferring

7
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funds for these purposes to more visible operating

programs. This practice only defers needed maintenance

and repair and results in more costly remedial actions in

the future. An effective capital improvement program is

well-documented and based on carefully conceived

funding criteria, giving elected officials adequate

justification for capital spending, even in difficult

financial periods.

The central features of an effective capital improvement

program are: (1) facility inventory and project

identification; (2) priority-setting; (3) assessment of

funding sources; and (4) capital budgeting.

Facility Inventory and Project Identification

The capital planning process begins with a

comprehensive assessment of existing facilities and

equipment. This review includes appraisal of the current

condition of existing infrastructure, identification of the

dates of construction or acquisition of all capital assets,

and estimation of the remaining useful life of each

capital item.

Related to the facility inventory is the development of a

schedule to provide for the regular maintenance, repair,

and replacement of existing infrastructure. It is

necessary to know the replacement costs of wastewater

treatment equipment and facilities in order to determine

budget needs and to develop user charge requirements.

* * * * * * * * * * * * * *

TIP: Operating appropriations for routine maintenance

must be carefuJJy coordinated with the schedule

developed for the capital improvement program, so that

the community does not waste money maintaining an

item it wiJJ soon replace. On the other hand, good

maintenance practices can extend replacement

schedules in the capital improvement program.

Following the inventory of existing facilities and

equipment, the community must identify future

demands for new capital investment. These

determinations are most effective when made against the

backdrop of a comprehensive land use plan that defines

a distinct "urban services boundary" (that region which

will receive urban services). With this clear sense of the

potential demand for services in the future, your

government is in a good position to determine

appropriate levels of funding for growth, as well as for

existing needs.

Priority-setting

You will probably be faced with more projects on your

capital facilities "wish list" than can be funded with

currently available resources. This resource allocation

problem requires an administrative process that ranks

each proposed project in order of priority. It is in this

priority-setting phase that citizen involvement is

solicited to build a level of support for the proposed

capital program. In the case of priority-setting for

wastewater treatment plants, you must also recognize the

clean water requirements of State and Federal

governments, as expressed most commonly in permits

establishing effluent limits for your treated wastewater.

**************

TRAP: Failure ofgrowing communities to invest in a

wastewater treatment system that keeps pace with their

needs can result in violations ofthe Clean Water Act,

possibly resulting in monetary penalties and a ban on

any new sewer hook-ups. Note, however, that EPA

grants generally are available only to meet existing

needs.

Your priority-setting process should include the

identification and evaluation of all potential financing

sources for each capital item.

Assessment of Funding Sources

The process of identifying new projects to be funded

must recognize the limits of available resources,

including borrowing. Examples of funding sources are:

• grants and intergovernmental transfers;

• low interest loan programs and bond banks;

• utility and enterprise system revenues;

• current general government funds;

• capital reserves; and

• general obligation and revenue bonds.

A good rule of thumb in the evaluation of financing

sources is to emphasize those which do not deplete the

community's limited resources. For example, the use of

grants is always preferable to draw-downs of capital

reserves. Similarly, low-interest loans from State and

Federal agencies are almost always more desirable than

the direct issuance of bonds by the local government.

**************

TRAP: A community that delays construction ofa

needed treatment plant in the hope ofobtaining a grant

or better financing arrangements runs a serious risk of

substantial penalties through court-ordered fines ifthe

delays result in continued (or new) discharges of

inadequately treated wastewater in violation ofthe Clean

Water Act.

I
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As you consider the appropriate mix of borrowing and

"pay-as-you-go" financing of capital improvements, you

must recognize the practical (as well as the legal) limits

to each approach. Pay-as-you-go financing allows you to

avoid payment of interest on borrowed funds by

financing capital improvements with available funds

from accumulated user fees and charges, assessments,

capital reserves, and taxes.

A principal disadvantage of pay-as-you-go financing is

the heavy burden you will place on current residents to

fund facilities that have long useful lives. This issue of

intergenerational equity argues that projects should be

paid for by all potential users, both current and future.

In addition, the limited resources available under a full

pay-as-you-go system may force your government either

to forego needed projects because current revenue

sources are inadequate or to raise taxes to unacceptable

levels to meet essential needs.

From a practical standpoint, very few governments rely

exclusively on a pay-as-you-go system, preferring to

implement a balanced system of capital financing from

current and future (projected and borrowed) sources.

Borrowing

Generally speaking, borrowing is necessary to fund

major capital projects. This must be done carefully

since most jurisdictions are subject to either

constitutional or statutory limits on the amount of

bonded debt that may be incurred. Other governments

are constrained by the requirement that voters must

approve issues pledging the general credit and taxing

power of the entity. In addition, there are the very real

perceptions of credit analysts and the investment

community that determine the ease of market access and

the interest rate at which funds will be available. It is

not too early for your community to begin consideration

of financing alternatives at this point in the planning

process.

Tax-supported debt:

There is no certain way of determining an appropriate

level of tax-supported indebtedness known as "general

obligation" or "G.O." debt for a particular local

government. An assessment of general obligation debt

capacity includes a range of credit considerations, such

as financial strength, economic diversity, and stability

and quality of management. There is a point, however,

at which the tax-supported debt of an issuer begins to

raise questions about its capacity to service that debt.

Investors often compare key debt ratios of an issuer to

other similar jurisdictions to determine the relative debt

burden. Among the most important ratios are: (1) net

tax-supported debt as a percentage of personal income;

(2) net tax-supported debt as a percentage of estimated

full cash value of taxable property; and (3) net taxsupported debt per capita. Your community's relative

position with regard to each of the ratios should be

considered in deciding whether to issue tax-supported

debt.

Moody's Investors Service and Standard & Poor's

Corporation, the nation's two largest municipal bond

rating agencies, use debt statistics from a broad range of

similar issuers to develop high, low, and median figures

for each of these indicators. Serving as the basis for

comparison, these data are useful to municipalities as

they develop their capital financing plans.

* * * * * * * * * * * * * *

TIP: Moody's publishes its "Selected Indicators of

Municipal Performance" each year and many

communities use these ratios as debt affordability

guidelines in the development oftheir capital

improvement programs.

Tax-supported debt is usually well received in the credit

market, reflecting the ability of the issuer to assess

taxable property to secure the issue. This general

obligation debt offers the additional advantage of

structural flexibility (e.g., the redemption schedule may

provide for level principal payment, level debt service,

or any reasonable variation thereof). Disadvantages

include the need to secure voter approval (in most

cases), the reduction in general borrowing capacity, and

the additional burden on taxable property.

Because general obligation debt typically pledges the

taxable resources of the entire community, such debt

should be used for general-use facilities. Where specific

use groups can be identified, the formation of special

taxing or assessment districts may offer a more

acceptable form of security.

* * * * * * * * * * * * * *

TRAP: Failure to recognize that tax-supported debt

must be employed selectively has, in the past, resulted in

citizen concern over the levels ofproperty taxation and

has contributed to the adoption ofproperty tax

limitation measures (e.g., Proposition 13 in California

and Proposition 2 in Massachusetts).

Revenue-supported debt:

Revenue-supported debt represents an alternative to the

use of general obligation debt that has been used much

more frequently by local governments in recent years.

The principal advantages of revenue debt are:

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• it is secured by fees and charges paid by the users of

the facility;

• it preserves general obligation borrowing capacity for

those projects that do not generate revenues; and

• it is usually not subject to debt limits.

However, interest rates are usually higher on revenue

debt than on general obligation issues. This is because

the pledge to secure debt service is limited to the

revenue source (charges to users of the wastewater

treatment facility). To provide protection against

fluctuations in the collection of revenues, issuers of

revenue debt must fund a debt service reserve and

pledge to maintain rates and charges at levels that will

ensure coverage of debt service.

Revenue debt capacity is generally fairly easy to

determine, because the limits of the revenue system are

clearly defined with a finite number of quantifiable

variables. Among the central considerations in the

analysis of revenue debt are:

• the demand for the service being provided;

• the operating history of the utility or enterprise;

• the degree of control over rates and charges exercised

by the issuing government; and

• the provisions made for unexpected contingencies.

Despite the fact that governments often enjoy a virtual

service monopoly (e.g., water and sewer systems), rates

must be maintained at reasonable levels. Comparisons

with other governments of similar size are useful in the

determination of "market" rates for various services.

**************

TIP: Connection charges) fees for extension ofa service

area) and other development charges are useful methods

ofassessing developers and new users for the burdens

they add to existing systems. This is particularly

important in cases where a new business may represent

an unusually heavy demand on a municipal service. A

chemical plant) for example) places a significant demand

on a wastewater treatment facility.

Capital Budgeting

As is the case with most governmental budgeting, the

development of the capital budget (using the capital

improvement program as a guide) is an exercise in the

allocation of limited resources. Unlike the operating

budget, where appropriations are made for goods and

services to be consumed during the fiscal year, capital

spending is a multi-year commitment. As noted

previously, this requires a coordinated effort to ensure

that on-going and proposed ventures are within the

government's ability to pay.

**************

TIP: A wastewater treatment facility requires provisions

for on-going operating and maintenance expenses) which

are often higher than the annual debt service obligations.

Special care must be taken to evaluate the potential

operating budget impact ofany capital investment.

In most cases, governments first apply available

resources through the operating budget to maintenance

and repair of existing facilities, with particular emphasis

on those items related to mandated improvements (e.g.,

wastewater treatment), public health, or safety. This

preventive maintenance approach helps ensure that an

existing capital item remains serviceable over its useful

life and avoids the need for extensive rehabilitation or

costly replacement.

The capital budget matches resources (current revenues,

grant, capital reserves, and borrowed funds) with the

spending priorities of the current year. If borrowing is

planned, the debt service obligations in future years

must be assessed vis-a-vis the impact on user fees,

charges, assessments, and tax rates. The on-going nature

of these debt service obligations and the need to

coordinate them with anticipated future capital

borrowings demonstrates the value of the long-term

perspective offered by the capital improvement program.

ASSEMBLING YOUR TEAM

It is important to develop at the outset of the process a

team of both in-house staff and outside consultants who

will be involved in guiding the project through to

completion. This team should include a wide range of

talents and experience, including the disciplines of

engineering, law, planning, finance, and management.

To ensure that the diverse but interrelated tasks which

make up the project are properly coordinated, one

member of the team should have responsibility for

managing the project from start to finish. Exhibit 2

summarizes the responsibilities of each team member. In

many cases, however, a single individual may be able to

cover several areas of responsibility; thus, a large team

may not be required.

The degree to which your in-house team will be able to

cover some or most of these functions will necessarily

vary with the specific organizational structure of your

community; nonetheless, persons with the following

I
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Exhibit 2

Roles ofTeam Members by Activity

Activity Roles

Legislative Body

Chief Administrator

Project Manager

Finance Officer

Purchasing Agent

Budget Officer In-House

Operating Manager

Construction Manager

Planner

Attorney

Bond Counsel

JOU"ide Financial Advisor

Engineer

Underwriter

All Phases

Planning Phase

Understanding Ground Rules P P R P P P P L P P

Capital Planning R P P P L P P P P

Assembling Your Team R L P P P P P

Project Planning R P R P P P P P L

Pre-Construction Phase

Short-Term Financing R R L P P P

Designing The Bond Issue R R R L P P P

Construction Contract R R L P P P P P

Project Budget P L P P P

Cash-Flow Forecast R L P P P

Setting User Charges R R R L P P P P

Construction Phase

Accounting Systems R L

Processing Transactions R R L P P

Investing Construction Funds R L P P

Managing The Contract R R R P P L P

Monitorir:g Project Progress R R R R P L

Completing The Project

Implementing User Charges R R R P L

Selling Bonds R P R L P P P P

Preparing For Audit R L P P P

Legend:

L= The individual performing this function should take the lead role in this activity

R= The individual performing this function should have a review/approval role in this activity

p= The individual performing this function should participate in this activity

11 I
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responsibilities should be involved throughout the

process:

• Legislative body: The community's elected body has

ultimate responsibility for the success or failure of

the project and its impact on the community. They

should actively involve themselves and keep

themselves informed throughout the process. In

addition to regular progress reports (quarterly during

the design phase and monthly during construction),

they should take formal action in adopting the capital

budget, hiring outside consultants, approving the

design and financing plans for the project, and

approving the bond sale.

• Chiefadministrative officer: This employee (City

Manager, County Administrator, etc.) should review

and interpret all information being sent to the

legislative body. The chief administrator should

involve himself or herself in the capital planning

process and the user charge setting process to

provide a management point of view and to assess

community impacts of the project.

• Project manager: The project manager is responsible

for overall supervision and coordination of the

project for your community. Because the elected

officials of your community are ultimately

responsible for the successful construction and

operation of the project, your community needs a

skillful project manager to oversee all project-related

activities. The manager should be a municipal

employee with experience in dealing with regulatory

agencies, federal grants, and construction projects.

The key concept is that a single person be given firstline management responsibility for the entire project.

• Finance officer: The finance officer should involve

himself or herself in every stage of the process. If

your community has both a treasurer and a finance

director, both should be involved in the facility

construction process. In the planning phase, this

involvement should center around evaluating

financing arrangements and assessing cost estimates.

In the pre-construction and construction phases, this

person should coordinate arrangements for shortterm financing and take the lead in establishing and

operating systems for budgeting, accounting, and

reporting on the financial aspects of the project. If

your community receives an EPA grant, this

employee will be responsible for satisfying the

financial requirements listed in the grant regulations.

As project completion approaches, the finance officer

should assume primary responsibility for structuring

the permanent financing and for audit preparation

and should also take part in the rate-setting process.

Note that while the finance officer has ultimate

responsibility for all of these activities, they will

usually involve employees in the finance office who

perform accounting and bookkeeping duties.

• Purchasing agent: The person responsible for

making purchasing and contract decisions has a key

role to play in the construction financing process,

assisting in selecting outside consultants and

managing the process for hiring a construction

contractor.

• Budget officer: In communities where the budget is

developed by an official other than the chief

administrator or the finance officer, the person

responsible for this function plays an important role

in construction finance. The budget officer should

take the lead in preparing the capital budget and

should be informed of financial proceedings

throughout the project, since each has an effect on

both current and future budgets.

• Treatment system manager and operators: If the

community currently operates a treatment system, it

is essential that those on the staff (often in the Public

Works Department) who are familar with it provide

input into the process of building a new facility. The

need for their participation in designing the plant is

obvious, but they have other roles as well. They may

be qualified to review engineering designs and

reports and to assist in monitoring financial progress.

The manager may be the employee in the best

position to serve as the construction manager, who

oversees construction and approves all payments (see

Chapter IV for a full description of the construction

manager's duties). The operating personnel should

also play an advisory role in the user charge study

process.

• Construction manager: The construction manager

serves as "construction auditor," providing oversight

regarding quality of construction work. His or her

functions include certification of the quality of

materials used and verification that construction

work was properly performed. Additional

information can be found in Chapter IV of this

handbook and in EPA's Management ofa

Construction Project: A Guide for Grantees.

• Planners: The community officials who are

responsible for forecasting and planning for

community growth play an important role in the

capital planning and project planning steps. Their

input is crucial to determining the capacity

requirements for all future construction projects,

including the wastewater treatment facility. They

may also possess demographic and economic

information that is necessary to evaluate community

impacts of the project, ability to repay debt or raise

user charges, and so on. This information will be

needed both in the planning phase and when user

charges are adopted as construction winds down.

• Attorney: Whether the community relies on inhouse counselor contracts for legal services, an

attorney who is familiar with your government's

I
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powers and legal structure, as well as Federal and

State laws, should be an integral part of the planning

and implementation team. Some of the areas where

legal advice is needed are: determining the legality of

various funding sources; reviewing grant agreements

and regulations; drafting and approving contracts

with outside consultants and with the construction

contractor; assisting the bond counsel in preparing

documents relating to debt issuance; and preparing

the ordinance that implements new user charges.

* * * * * * * * * * * * * *

TRAP: A community that leaves in-house

responsibilities to outside specialists loses some ofits

decision-making power and thereby relinquishes control

ofthe project.

The assistance of a number of outside specialists is

required to effectively structure and market a municipal

debt offering. Your community's purchasing agent

should direct the effort to select these specialists

competitively from among those individuals or firms

recognized as qualified to perform their respective

services. The key participants and a brief description of

their functions are provided below.

• Bond counsel: The importance of retaining

"recognized bond counsel" as soon as a debt offering

is contemplated cannot be overemphasized. An

attorney or firm is considered to be recognized bond

counsel if that person or firm has had extensive

experience in providing legal opinions for municipal

issues. A listing of recognized bond counsel is

provided in The Bond Buyer's "Directory of

Municipal Bond Dealers in the United States." The

legal opinion of recognized bond counsel contributes

to the marketability of a debt offering by giving

investors assurance that the issue meets certain legal

tests.

Bond counsel's principal functions are: (I) to approve

the legal authority of the government to issue the

debt; and (2) to certify that interest income on the

bonds is exempt from taxation. Typically, bond

counsel's role extends well beyond this narrow scope.

Other services frequently include:

- identifying statutory and charter provisions that

dictate the way the debt may be structured;

- drafting original bond resolutions, ordinances, and

trust indentures;

- preparing the notice of bond election (if necessary);

- reviewing and approving the notice of sale;

- approving the form of the note or bond; and

- attending the note or bond closing to ensure that all

required documentation is available in proper form.

Bond counsel's role is extensive, but should be

limited to legal considerations. Issues relating to the

sizing and structuring of the bond issue,

determination of bidding constraints, and timing of

the sale should be addressed by the financial advisor

or underwriter in consultation with members of the

issuer's staff.

**************

TIP: There is no substitute for use ofrecognized bond

counsel in the debt issuance process. There is an

excellent chance that the proposed issue will not be

marketable without the opinion ofrecognized bond

counsel.

• Financial advisor: The principal function of the

financial advisor is to assist the issuer with the

structuring and marketing of the debt offering. You

should retain an advisor prior to or shortly after

selecting a bond counsel. The financial advisor

should be involved in the coordination of the new

issue with outstanding debt and any other offerings

proposed by the capital improvement program.

The following services are among those provided by

the financial advisor:

- assisting in developing the capital improvement

plan, the capital budget and the capital budgeting

process;

- assisting with the decision to issue debt and the

type of security: general obligation or revenue debt;

- determining the structure of the debt and the terms

and conditions of sale (including whether or not the

issue should be sold competitively or through

negotiated sale);

- developing a schedule for the successful issuance of

debt that identifies the individual responsible for

the timely performance of each activity;

- preparing the required disclosure documents;

- securing municipal debt ratings;

- promoting the sale (for competitive issues);

- verifying bids (for competitive issues) and advising

on the acceptability of interest rates bid; and

- providing follow-up information on the results of

the sale.

Just as bond counsel should not be expected to

provide financial advisory services, the financial

advisor should not be called upon to provide legal

advice. The financial advisor will work closely with

13 I
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bond counsel to ensure that all1egal issues are

addressed, but a clear delineation of responsibilities

is important.

**************

TRAP: Ifthe proposed issue is to be sold through

negotiated sale, the firm selected as underwriter should

not also serve as financial advisor. The financial

advisor's worth is in his or herindependence from any

financial interest in the underwriting ofyour debt.

**************

TIP: Additional financial advice is often available from

State agencies and associations ofcities or counties.

These sources can be useful during the early planning

stages, but should not be seen as a substitute for a

financial advisor.

• Engineering consultant: (Note: the engineering

consultant may also serve as resident engineer and

inspector. See "Construction Management

Evaluation and Project Management Conference

Manual," USEPA, December 1983.) An important

step in your community's effort to develop improved

wastewater treatment facilities is to work with

engineers of the highest caliber, competence, and

professionalism. This does not mean that the choice

of an engineering firm is limited to large, national, or

"big name" companies. Quality engineering

assistance is available from many smaller, regional

firms all across the country. However, you must take

great care in the choice of an engineering firm. The

consequences of poor engineering include excessive

cost (both capital and operating) and, possibly, the

failure of the system to meet pollutant discharge

requirements.

The most significant factor in the choice of an

engineering consultant should be the track record of

the firm. Your purchasing agent should prepare a

Request for Proposals (RFP) (see Construction

Grants 1985 ("CG 85"), USEPA, July 1984.). A

significant difference between the engineer's

estimated costs and the contractor's actual costs is a

negative indication of the firm's ability to protect the

interests of the community. All engineering firms

responding to the RFP should be obligated to certify

the accuracy of these data at the risk of

disqualification in the RFP process.

Prior relationships with engineering firms should not

determine the selection of an engineering consultant

for a major capital project. The significance of such a

major investment virtually demands competitive

.selection of the consulting engineer to protect the

financial interests of the jurisdiction. A century of

public procurement history has demonstrated that

competitive negotiation is the best technique for

choosing the most cost-effective, qualified advisory

services. Competitive negotiation for consultants

should not be confused with competitive bidding for

purchasing goods. In selecting consultants both the

cost and the qualifications of each candidate. should

be included in the evaluation criteria. For

information regarding an optional method of

procuring engineering services see "CG 85."

• Paying agent and bond registrar: Most communities

that are regular issuers of debt have already retained

the services of a paying agent and registrar, which are

usually provided by banks. The services include

payment of principal and interest when due on

outstanding debt and maintenance of records of

ownership for registered bonds. Most relationships

for such services are multi-year contracts that specify

charges based on the number of transactions

performed. Such transactions include interest

payment, bond payment, the process of transferring

bonds between owners, and related record-keeping.

Many jurisdictions have served as their own paying

agent in the past. Now that Federal law requires the

registration of all municipal debt with a maturity of

over one year, the paying agent and registrar function

is more complex administratively. In order to avoid

the increasingly complex duties of paying agent and

registrar, issuers should leave these functions to the

financial institutions.

• Underwriters: The underwriter is the bank or

investment banking firm (or group of same) that

purchases the debt directly from the issuer and

remarkets the debt to the investment public. The

underwriting community consists of firms of varying

size that specialize in the local, regional, or national

debt market. The size of the debt offering being

considered will determine where the issuer should

look for underwriting services.

For competitive sale, the underwriter is chosen by

specifying the terms and conditions of sale (in the

"Notice of Sale") and accepting bids on the issue at a

predetermined place and time. The bids are opened

I
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and the issue is awarded to the underwriter offering

the lowest interest rate. This method is preferable for

nearly all general obligation debt offerings and many

simple revenue bond issues. However, if the issue is

complex, if it is the first offering of a new issuer, or if

it is being sold quickly to take advantage of favorable

market conditions, a negotiated sale may be more

efficient.

The best method of selecting an underwriter for the

negotiated sale of an issue is to develop a Request for

Proposals (RFP) that solicits detailed information

about the experience each firm has had with the

successful marketing of similar issues.

Once chosen, the underwriter will work closely with

bond counsel and the financial advisor to develop a

structure that both meets the issuer's needs and is

attractive to the investment community. (The

financial advisor's principal function at this point is

to ensure that the emphasis is on the former, rather

than on the latter.) Following the structuring of the

issue, the underwriter will consult the firm's sales

force to determine proposed interest rates for each

maturity at which the debt can be sold in the

secondary market. The financial advisor will then

offer advice on the acceptability of these rates.

**************

TIP: Care should be taken in the selection ofan

underwriter to ensure that the firm chosen is

experienced in the remarketing ofthe specific type of

debt being offered and is able to reach the market (local,

State, or national) in which the debt can be sold most

efliciently.

* * * * * * * * * * * * * *

TIP: In all advisory relationships, the contract should

clearly state the scope ofservices to be provided, the

timetable for completion ofprincipal tasks, the basic

compensation arrangements, and some understanding of

hourly charges for additional work (upon written

authorization by the community).

PROJECT PLANNING

If your community will receive an EPA grant, you must

complete and submit a facility plan, which determines

the facility design that most closely matches your

community's needs. Once your State reviewing agency

approves the facility plan, you may direct your engineer

to begin detailed design work. Even if you will not

receive a grant, you are more likely to get the most costeffective facility by carefully considering available

alternatives. The project planning process, whether at

the facilities plan stage or in specific design work,

consists of estimating and evaluating both capital and

operation, maintenance, and replacement (OM&R)

costs.

Estimating Capital Costs

A typical wastewater treatment system involves a

considerable variety of components: sewer pipe, pumps,

wiring, and plant, to name a few. The construction

activity will frequently involve a main (or prime)

contractor and several subcontractors. It is not a simple

matter to estimate the cost of construction, and it is an

extremely important matter. Disaster can occur unless

the actual cost is close to the estimates used to decide

whether or not your community can actually afford to

build and operate the plant.

It is generally the procedure that the engineering

consultant will provide the capital cost estimate.

However, the ultimate responsibility to manage the

process is yours.

When discussing costs with the engineering firm, insist

on cost estimates with an appropriate level of detail.

Each major component (treatment plant, sludge

handling and disposal, pump stations, interceptor

sewers, collection sewers, etc.) should have its own cost

estimate. Compare your cost estimates with comparable

projects using the same technology by using unit

measures such as cost per mile (for sewers), cost per

capita (for total system), etc. EPA publishes assistance

materials to help you determine cost norms for different

types of treatment technologies. The Computer Assisted

Procedure for the Design and Evaluation of Treatment

Systems (CAPDET) and Construction Costs for

Municipal Wastewater Treatment Plants: 1973-1982

may be particularly useful in this effort. Ask for an

explanation of costs that seem out of line (in either

direction: high or low).

* * * * * * * * * * * * * *

TIP: The selection ofthe wrong technology can be one

ofthe most expensive mistakes a community can make.

You must be sure that the technology being considered

is the most appropriate (and cost-effective) for its

purposes. Alternative treatment and collection

technologies should be carefully considered, especially in

small communities.

15 - "11
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When developing cost estimates and reviewing your

engineer's estimates be sure to consider project-related

expenditures which are frequently ignored but are very

real. Examples include cash-flow financing of Federal,

State, and local shares, interest during construction,

repayment of loans from other funds, the local share of

planning and design costs, legal, financial and other fees

(e.g., the cost of printing the official statement,

printing the bonds, obtaining a credit rating, use of a

signature company, financial advisory services, bond

counsel, and the bond election), and any other fees

which may be applicable in your situation. If you will

receive an EPA grant, your engineer should provide an

estimate of capital costs that are not eligible for EPA

funding.

Estimating Operating Costs

The estimation of the capital cost of a project usually

receives a lot more attention than the estimation of its

operating costs. The planning and building of a new

facility is often viewed by both the community and the

engineer as more of a challenge than the actual operation

of the facility. The capital cost of a treatment facility

generally represents the need to issue debt, which

generally involves the legislative body and frequently a

vote of the populace. The numbers tend to be large and

very impressive; it may be the most costly decision the

governing body of your community ever makes.

Notwithstanding these factors that focus attention on

capital costs, you should insist during planning and

design on an accurate determination of operating costs

and a facility that will be simple and inexpensive to

operate. An error in the calculation of operating cost can

be as much as nine times more costly than the same size

error in the capital cost estimate. The reason for this is

that capital costs are funded from debt proceeds and

repaid over time, as are any errors in capital cost

estimates. With a 20-year bond at 10 percent interest,

the community pays annual debt service equal to about

11 percent (or one-ninth) of capital costs. In addition,

. the total capital cost to the community may be reduced

by grants from the State or Federal government. Errors

in operating cost, on the other hand, are paid for every

year-and in full. Thus, an accurate estimate of the

annual cost of operating the entire system may be more

critical than the estimate of capital cost. EPA publishes

Operation and Maintenance Costs for Municipal

Wastewater Facilities to assist you in evaluating

operating cost estimates.

Virtually all your operation, maintenance, and

replacement (0, M&R) costs will be composed of the

following: labor, power, chemicals, sewer maintenance,

and billing. Never assume that the operating cost

indicated in the facility plan is complete and accurate.

Insist on a reevaluation of the operating cost for the

entire system and an updating of costs to reflect current

prices for labor and materials. You can use the Financial

Capability Guidebook produced by EPA to help prepare

complete estimates. This caution is particularly

appropriate for a facility plan which is for a system

expansion, since some engineers will only include cost

estimates for the portion of the system being expanded.

Don't assume; ask for a statement in writing.

Are the Costs Reasonable?

Once you have determined that the cost estimates

provided are complete, you may discover that you are

facing a more expensive project than you anticipated.

Determining whether such costs are reasonable is not a

simple matter, but experience has provided some

indicators of situations that deserve closer scrutiny. Your

State may have other indicators that can also be used as

guidelines.

• Size of community: Small jurisdictions (those with

population less than 10,000 and even more

emphatically less than 3,500) usually have higher per

capita costs than large jurisdictions. As a result, there

is less margin for error.

• Extent of sewers: If a community is installing sewers

for the first time, that component will generally be a

major cost, if not the single largest cost, of the entire

system. In fact, small communities often cannot

afford both conventional collection and treatment

facilities, even with Federal grants.

• Type of technology: For small communities the type

of technology can be a major contributor to high

cost. In particular, certain types of activated sludge

and physical-chemical systems tend to be very

expensive and have high 0, M&R costs.

• Total capital cost per household (without a grant): If

the residential share of capital cost of the project

divided by the number of households is greater than

$4,000 (for an upgrade or expansion project) or

$6,000 (for a new system), then the capital cost may

warrant reexamination.

• Total annual cost per household (includes capital cost

plus O&M): An annual total cost per household

greater than $300 may be a cause for concern.

Annual household cost should also be measured

against annual household income.

• Allowance for future flow: An allowance for growth

of greater than 50 percent may be an indication of

over-design, unless the estimate is substantiated by

commensurate growth rates in the recent past. A

realistic appraisal of your community's growth

potential is necessary to determine future flows.

• Capital cost of sewers per household: A per

household cost of greater than $4,000 suggests that

the project may have excessive sewering.

!I
Preventing Costly Reexamination of Your Project

The following steps should be considered at the initial

phase of the project. It is important to note that EPA

regulations don't allow for payment of redesign in the

event of erroneous initial judgement. Nor will EPA pay

for replacement costs of an inappropriate facility.

Therefore, the following should be kept in mind in

designing your project:

• Review the facility plan and basic design data for

cost-saving measures: Consider reducing or

eliminating items not essential to operation or safety.

Brick-faced buildings, terrazzo floors and paved

roadways may do nothing to improve effluent

quality.

• Reduce the scope of the work: Consider limiting the

service area, especially by eliminating unnecessary

sewering through sparsely populated areas. It can be

much more cost-effective to rehabilitate or replace

existing on-site systems and to establish communitywide management of the systems than to construct

sewers. Where current on-site systems will not work,

consider rehabilitation or the use of innovative or

alternative (IIA) on-site systems.

• Reduce facility size and stage construction: Consider

reducing or eliminating the sizing for future growth.

Similar results can be achieved by staging

construction according to need (when revenues will

be available to finance the expansion).

• Reconsider less expensive technologies: Take another

look at alternative sewers, cluster systems, trickling

filters, lagoons, sand filters, overland flow, oxidation

ditches, and low load aeration technology.

• Share support facilities and operations with

neighboring jurisdictions: Sharing such costs as labs,

maintenance equipment, and supplies can reduce

personnel and other cost as well.

It is important to ensure that all simple, low-cost

alternatives were considered seriously. Since the most

. cost-effective alternative may change with time, be

cautious about relying on an old facilities plan. EPA

regulations now require a reexamination of the

environmental impacts of any plan five or more years

old. If you intend to apply for an EPA construction

grant, you should file the formal grant application when

you have completed detailed design work. Once your

application is approved and a grant awarded, you will

need to complete preconstruction activities so that you

can begin construction as soon as possible.

CONCLUSION

Exhibit 3 reviews the functions performed in the

planning process. At this stage, you are standing safely

on first base. You have stepped back to evaluate all of

the legal and regulatory restrictions that you face and

have taken steps to comply with each. You have

completed an analysis of all of your community's capital

needs and the available financing. You have developed

plans for your project, including how it will be built,

whether it is appropriate for your needs, what it will

cost, and how long it will take. You are ready to head for

second by:

I) lining up short-term financing;

2) designing the long-term financing;

3) awarding the construction contract;

4) preparing the project budget;

5) developing the cash-flow forecast; and

6) beginning a user charge study.

17 _ II
I 18

Exhibit 3

Matrix ofFunctions Performed in the Planning Phase

I

* * * * * * * *

What is Done Who Does it When To and With Whom

UNDERSTANDING Community's As soon as All employees

GROUND RULES Attorney construction is who will be

contemplated involved

CAPITAL Budget Annually Department

PLANNING Officer Heads, Chief

Administrator

ASSEMBLING Chief As soon as Legislative

YOUR TEAM Administrator construction is Body

contemplated

PROJECT Engineer When needs Operating Manager,

PLANNING are identified other internal

team members

OVERALL Project Throughout the All team members

PROJECT Manager project involved in

MANAGEMENT this phase

PLANNING
CHAPTER III

SHORT-TERM FINANCING

This subsection focuses on structuring an interim

financing program that provides funds when needed to

meet construction costs and takes full advantage of

legally authorized reinvestment earnings. The process

for arranging permanent financing is described later in

this Chapter and in Chapter V. You are cautioned to

undertake short-term borrowing only after careful

planning and with the full advice and consent of bond

counsel.

While it is difficult to make statements applicable to all

situations, it is generally the case that a local government

will finance a capital project with a combination of

short-term and long-term debt. Short-term debt

instruments (typically Bond Anticipation Notes (BANs)

or Grant Anticipation Notes (GANs) are used to

provide cash-flow financing during the construction

period and long-term debt is used to provide permanent

financing once the actual cost of the project has been

established. Alternatively, local governments may issue

long-term debt after accepting bids on construction

contracts and thus avoid the need to secure interim

financing.

With the planning process complete, you have made an

important first step toward your goal of successfully

building a treatment system; you now have an

understanding of the legal issues, a capital plan, a team

in place, and a design for the facility underway. Before

you move into scoring position and are ready to build,

however, you must do some more preliminary work in

the pre-construction phase. This work will consist of

selling short-term notes so that you will have adequate

cash to pay the costs of construction, designing the

features of your permanent financing, developing a

construction contract, preparing a project budget and

cash flow forecast, and beginning a study to set new user

charge rates.

The

• pre-constructIon

phase of

financial

management:

movIng • to

second

21
I 22

Short-Term Financing Alternatives

For wastewater treatment facilities, various forms of

short-term financing methods are available. Your

community may consider the issuance of bond

anticipation notes (BANs), grant anticipation notes

(GANs), or some combination of the two.

BANs are issued in anticipation of permanent financing

of the project which will occur at some later date

through the sale of bonds. Security for the BAN is

provided by the issuer's ability to access funds in the

credit markets by selling general obligation or revenue

bonds. Thus, to ensure a favorable reception by

investors, all legal requirements for the long-term

financing must be satisfied before the BANs are

authorized and marketed. For a general obligation bond

issue, this typically means securing voter approval.

When the permanent financing is to be provided from

revenue bonds, a feasibility study, projections of revenue

flow, and other forecasts of project viability are required.

The investor in the BANs wants to be sure that the

bonds that secure his investment can and will be issued

as scheduled.

As the name implies, GANs are a short-term instrument

secured by the expected receipt of grant funds. Such

notes are a viable financing alternative only when the

issuer has received a firm commitment that the grant

will be made. GANs may be secured either by EPA

grant, State grants, or both.

Because GANs are secured by the receipt of the grant

for wastewater treatment, care must be taken to

accurately estimate grant-eligible costs. A conservative

approach is important in developing this estimate. Once

expenditures have been made for grant-eligible

expenses, you apply to EPA for reimbursement.

Assuming all required procedural steps have been

followed, EPA will usually provide reimbursement

within thirty days.

**************

TIP: It is essential that grantreceipts be segregated in a

separate fund or account to provide for redemption of

the GANs upon maturity. Most issuers enterinto trust

agreements that give note investors comfort that the

funds wiJJ not be diverted to any other purpose. One

community that failed to understand the segregation

requirements ofits note indenture placed too little

money in the redemption fund and defaulted on its

notes.

GANs and BANs issued for wastewater treatment

construction financing usually mature within 18 to 36

months of the date of issue. In some cases, governments

will issue notes for a period shorter than is necessary for

completion of construction and then reissue or "rollover" the notes at maturity. This approach takes

advantage of the lower interest rates on short

maturities, but exposes the issuer to some risk that

rates will be higher on the roll date (plus the added costs

of multiple issues). Your financial advisor and bond

counsel should be consulted regarding a note structure

that is appropriate to market conditions at the time of

sale.

Arbitrage Earnings During Construction

An appreciation of the financial advantage of interim

financing requires an understanding of the concept of

arbitrage. In the municipal market, arbitrage refers to

the reinvestment, at taxable interest rates, of funds that

were borrowed at lower tax-exempt interest rates.

* * * * * * * * * * * * * *

TRAP: In most cases arbitrage earnings are subject to

strict limitation by regulations ofthe Internal Revenue

Service. Because violation ofthese regulations can result

in the loss oftax-exempt statusJ it is important that bond

counsel be involved in the sizing and structuring ofany

note or bond offering (as well as the proposed

reinvestment schedule).

If the issuer is to take full advantage of the arbitrage

earnings short-term borrowing allows, accurate estimates

of total project costs and the construction disbursement

schedule are essential. The engineering consultant, in

conjunction with the prime contractor, should provide a

detailed (at least monthly) statement of expected cash

flow and estimates of Federal (and, if appropriate, State)

reimbursements. These statements should be examined

with great care to guarantee that funds will always be

available to make required payments-induding those

for BAN interest should the term of the financing be less

than the duration of the construction phase.

**************

TRAP: The grant funds must be available by the stated

maturity date ofthe GANs. To ensure their availabilityJ

the issuer must take into account the delays between

approval ofa construction expense and receipt offunds

from the EPA.

I
I

Exhibit 4

Construction Draw-Down

and Interest Earning Schedule

for a $5,000,000 Project

Over a 12-Month Construction Period

23 I

Construction Fund Debt Earnings Net

Service on Const. Debt

Month Balance Expenses At 6% Fund at 7.5% Service

0 $5,000,000 $ 0 $ 0 $ 0 $ 0

1 5,000,000 100,000 0 0 0

2 4,900,000 200,000 0 30,625 0

3 4,700,000 400,000 0 29,375 0

4 4,300,000 500,000 0 26,875 0

5 3,800,000 700,000 0 23,750 0

6 3,100,000 900,000 0 19,375 0

7 2,200,000 900,000 0 13,750 0

8 1,300,000 600,000 0 8,125 0

9 700,000 300,000 0 4,375 0

10 400,000 200,000 0 2,500 0

11 200,000 100,000 0 1,250 0

12 100,000 100,000 300,000 625 139,375
I 24

The disbursement schedule shown in Exhibit 4 is fairly

typical for a major capital construction project. In this

case a 12-month construction period is assumed.

Assuming the net interest cost of the one-year note

issue is 6.00 percent, the total interest payments are

$300,000. By reinvesting the note proceeds in taxable

securities (at an assumed average rate of 7.5 percent)

until needed to meet construction expenses, the issuer is

able to off set its interest costs and reduce the effective

rate of the borrowing. The net effect in the example

shown is to reduce debt service from $300,000 to

$139,375.

Advantages of Short-Term Financing

Using temporary financing during the construction

phase of a project followed by permanent financing .

offers several advantages. Since BANs are usually paId

for by either the sale of a new issue of notes or by the

sale of long-term debt, their use allows the deferral of

principal payment. If a new system is being constructed,

this matches the greatest burden of debt service with the

revenue flow from benefiting users.

During periods of high interest rates, BANs (which have

low interest cost relative to long-term debt) can be used

to defer the long-term financing until rates have

declined. Unfortunately, there is no guarantee that rates

will decline, so the use of BANs for this purpose

constitutes a risk as well as an opportunity.

Issuing BANs also allows the amount which must be

permanently financed to be determined exactly. Longterm financing before completion of construction may

result in additional financing later if cost estimates were

not accurate. This can be both embarassing and costly.

If a wastewater system is being constructed with revenue

debt, the community may need to defer debt service

payments until the new plant is operational. Under these

circumstances, an interim borrowing, in the form of

BANs and GANs, is appropriate. A second option

. would be to sell bonds that are structured to defer the

first principal payment until after project completion. In

this case, enough money is borrowed to pay interest on

the bonds during construction. This amount is known as

capitalized interest.

The process outlined above is complicated and

extremely important. In general, it is highly advisable

that the community employ the services of an

independent financial advisor (an expert who has no

financial involvement in the way the interim borrowing

is structured) to coordinate the various steps and offer

objective advice about the method of funding which is in

the best interest of the community.

DESIGNING THE BOND ISSUE

As noted above, you must make some decisions about

how you will finance the project in the long-term before

you can arrange short-term financing. Once you have

received the proceeds from short-term financing, you

can complete the design for your long-term issue.

Exhibit 5 shows that the design phase is just one of the

three distinct parts of the bond sales process. It is also

the only one that usually takes place before construction.

The other phases, marketing and closing, are discussed

in Chapter V.

Designing the Issue

The first decision in designing the bond issue is the type

of bond (general obligation or revenue). In a wellmanaged agency, this decision will be made in the

capital planning process, well before construction is

underway. (See Chapter II for an outline of factors that

should be considered in determining bond types.) No

interim or construction financing can be marketed

effectively until the form of the long-term or permanent

financing has been determined.

One of the most important activities, undertaken early in

the process, is the sizing of the bond issue. The simplest

method is to borrow the amount of construction costs,

less grants from EPA and the State, upfront cash, and

other funding sources. Municipalities may also choose to

capitalize, or include in the amount to be borrowed, the

costs of issuing bonds (bond counsel, printing,

insurance, etc.) and the interest on short-term financing.

A financial advisor can help determine what costs should

be capitalized, if any.

The term of the bonds, or numbers of years until they

mature, must also be determined.

**************

TIP: The term ofthe bonds should never exceed the

expected useful life ofthe facility. Ifit does, you may

end up paying debt service on two bond issues for the

same purpose. This is a particular concern where 40-

year loans are used. With this in mind, you have some

flexibility in selecting a term that closely matches the

desired cash-flowpattern.

You should keep in mind that while shorter terms

generate lower interest rates and total interest payments,

they result in higher annual payments. Ten- and twentyyear bonds are most common for treatment facilities, but

thirty-year bonds may be considered where the annual

debt service costs of shorter term bonds are too high for

the community to bear.

II
I

Exhibit 5

The Bond Sale Process

25- I

Determine

Security

Method of Sale

Maturity Structure

Denomination

Registration

Call Privileges

Interest Structure

Bond Indenture

Insurance

Prepare

Official Statement

Notice of Sale

Bid Form

Indenture

Award Bids

Print Bonds

Close The Issue

Establish Payment

Mechanisms
26

You must also determine the method by which the

bonds will be sold. Virtually all debt is sold through

either competitive or negotiated processes. In a

competitive sale, the issuer selects a sale date and solicits

sealed bids. Bids are opened on the specified date and

the bonds are sold to the bidder who offers the lowest

total interest cost. In a negotiated sale, the issuer selects

one bank or investment banking firm and then

negotiates the interest rate and other terms of the sale.

State laws usually govern which method may be used,

with most States requiring that G.O. bonds be sold

competitively. Generally, competitive sales are more

advantageous to the issuer.

Once the basic structure of the issue is determined, the

finance officer and financial advisor must determine the

other aspects of the sale:

• Method of retirement (maturity structure): Most

bonds issued by local governments are serial bonds.

In this type of bond structure, a portion of the

principal is retired each year, along with the regular

interest payment. The structure that is most

appropriate for revenue-supported debt is serial

bonds with equal debt service payments. The

principal payment increases each year and interest

declines so that annual principal and interest

payments are approximately equal, not unlike a

mortgage on a private home (with the significant

difference that bond payments are made semiannually, with the principal component usually being

paid on only one of the semi-annual dates). Many

municipalities prefer this schedule because the taxes

or fees levied to repay them can be held constant

each year. Unlike serial bonds, term bonds are

retired at a single, future maturity (or at specific

dates during their life) from sinking funds

accumulated during the life of the bonds.

• Denomination: This is the face amount (or par value)

of each bond that the issuer promises to pay on the

date the bond matures. It is common for bonds to be

issued in multiples of $5,000.

• Registration: Current Federal law requires that issues

with a maturity of longer than one year be registered.

The owner's name is listed in the books of the bond

paying agent and registrar (and the issuer, if the

issuer is acting as co-registrar). Interest payments are

sent automatically to all registered owners when due.

Prior to 1983, most municipal bonds were issued in

bearer form. Under this system, there was no record

of bond ownership; payments were made only when

bonds and interest coupons were presented to the

paying agent by the owner.

• Call privileges: A bond that is callable may be retired

before the maturity date at the option of the issuer.

Usually this feature is considered when interest rates

are high. For the issuer, it has the advantage of

reducing debt levels if revenues are higher than

predicted at the time the bonds were sold.

• Interest structure: Interest payments are usually

made twice a year until the bond matures, as

specified on the successful bid for the bonds. The

rates may vary (if State law permits) depending on

length of maturity. The issuer may wish to restrict

the number of different interest rates and the

maximum range of rates to permit on bids; this

decision should be made following consultation with

the financial advisor.

• Bond indenture (for revenue bonds only): Because

they rely on restricted funds rather than a general

pledge of the issuing government, nearly all revenue

bonds are subject to special agreement between the

investor and the issuer. This agreement (known as an

indenture) often includes a requirement that bond

funds be held in a special fund to guarantee that the

funds are kept separate from operating funds. The

manner in which the bond funds may be used,

requirements to build cash reserves, and how

operating income from the facility should be

handled are spelled out in the trust indenture in great

detail. A financial advisor and a bond counsel will be

needed in this part of the design process.

**************

TIP: Bond indentures frequently require that funds be

reserved in separate accounts throughout the life ofthe

bonds in order to provide additional protection for the

bondholder. Excessive segregation offunds may lead to

significant inflexibility, possibly resulting in aninability

to legally pay legitimately incurred costs despite the

availability ofcash in other accounts. An appropriate

minimum number offunds is two, one for operating and

maintenance expenses and one for debt redemption.

• Insurance: An increasing number of municipal bond

issues are insured. In this arrangement, the issuing

agency pays a fee (generally one-half to one and onehalf percent of the total debt service on the issue) to

purchase insurance to payoff the bonds should the

issuer be unable to do so. The presence of insurance

results in a better bond rating and lower interest

costs. Bond insurance is often difficult to obtain for

revenue bond issues.

THE

CONSTRUCTION CONTRACT

The construction contract is your best chance to

guarantee that the job will be done right. Your

purchasing agent, engineer, and attorney should work to

ensure that it includes adequate protections. Much of

I
I

the contract will focus on the physical aspects of the job.

These most important items must be incorporated into a

Statement of Work that describes in detail what is

expected of the contractor, and a schedule that sets out

in objective (measurable) form what will be done by

what date.

**************

TRAP: Too often, construction schedules are vague,

containing deadlines for amorphous events such as "25

percent completion. " These schedules are open to

interpretation and leave the community with little hope

for enforcement. Schedules should relate to specific,

measurable events, such as "complete excavation as

described in Section 4.15 ofthe specifications," "install

and test sewer lines on Main Street," and the like.

In addition to these "physical" contract provisions, the

contract must have some financial provisions as well.

The most important are:

• Payment provisions: The contract should state how

often the contractor will be paid and how the

payment will be measured. It is to the community's

advantage for the purposes of cash-flow forecasting

to state a specific, monthly date for the contractor to

submit bills and a minimum time for the community

to review the submission before payment. (Ten days

is probably an appropriate review period, but you

should agree on a period with your engineer.) The

contract should specify that monthly payments will

be based on the contractor's claim of progress toward

completing the construction schedule (on a

percentage basis) and that payment will not be made

until both the engineer and the construction manager

certify that the contractor's estimate is accurate. The

contract should also state that payment requests must

be accompanied by written progress reports that

support the request.

• Retainage: Since every construction project requires

some modifications and correction in the period

between completing the project as scheduled and

final acceptance, the community should incorporate

in the contract a provision to retain from each

payment a percentage to be held until final

acceptance. Retainages commonly run from five to

ten percent of each payment. Once the contractor

submits a final bill, the retainage should be held until

the finance officer receives written certifications from

the engineer and the construction manager that the

project is acceptable and that retainage may be

released. It is important to note that EPA grant

recipients may only request payment from EPA for

costs actually incurred. Therefore, until the retainage

has been paid to the contractor, the grant recipient

should not seek reimbursement from EPA for that

amount.

• Performance bond: The contractor is required to post

a performance bond at its own expense in the amount

of the contract. A performance bond is an insurance

policy that guarantees completion of the job. If the

contractor fails to complete the contract, the

community may demand that the insurance company

either find another acceptable contractor or pay the

community the value of the uncompleted part of the

project. Do not allow any work to be done by the

contractor until a performance bond is presented.

TIP:

**************

Keeping good records is absolutely essential to a

successful project. Both you and your contractor are

required to maintain proper records. Millions ofdollars

ofproject costs have been disallowed by EPA due to

poor orincomplete record keeping on the part ofproject

managers or contractors, or both. See "EPA Office of

Inspector General Report to Congress," USEPA, Fiscal

1985.

EPA requires that every contract contain certain

fundamental clauses. Refer to the model clauses in 40

CFR 1030, or use your own equivalent clauses to cover

the required contract clauses. Some of the matters

covered include:

• Change orders: The dollar value of the contract will

initially be for the competitively established price of

the contract awarded to the low bidder. During the

actual construction period, however, it may be

necessary to make changes that result in a higher

price. Your contract should specify a routine for

dealing with change orders. You should require that

the engineer describe and justify each change order

and that the construction manager and the legislative

body approve it. (See Management ofConstruction

Change Orders, USEPA, March 1983.)

• Termination: The contract should clearly state how

the community may terminate the contract. You

should reserve termination rights both in the event

that the contractor fails to meet the provisions of the

contract (see "default" below) or simply for the

convenience of the community. This last provision is

most commonly used when there is a problem with

continued financing for the project. The termination

provision should clearly state how the community

will notify the contractor of termination and how the

work to date will be measured for the purpose of

payment.

2T I
I 28

• Default: The contract should clearly define the

conditions under which it may find the contractor

"in default" for the purposes of withholding

payments or terminating the contract. Common

causes of default are failure to deliver materials or

services on schedule, delivering materials that do not

meet the specifications, or failing to meet reporting

requirements.

• Audit; access to records: The contract must contain a

provision requiring your contractor to maintain

books, records and other evidence pertinent to

performance on EPA funded works. The prime

contractor must, in turn, make this provision

applicable to all subagreements he awards in excess

of $10,000. The right of access clause applies to

financial records pertaining to all subagreements,

except formally advertised, fixed-price

subagreements, and to all subsequent change orders

and subagreement amendments.

It is crucial for EPA grant recipients to be aware of and

refer frequently to the EPA regulations governing

construction contracts. In addition to Construction

Grants 1985, you should obtain copies of the Audit

Access to Records: 40 CFR 33.1030 (9)j Prevention and

Resolution ofContractor Claims: EPA Construction

Grant Program Guidance for Municipal Grants,

USEPA, March 1985; Construction Grants Program for

Municipal Wastewater Treatment Works: Handbook of

Procedures, USEPA, October 1984; and Management of

Construction Change Orders: A Guide for Grantees,

USEPA, March 1983. EPA regulations and most State

laws require that the construction contract be let

through the process of competitive bidding. This process

consists of these major steps:

• Preparing bid documents: EPA procurement

regulations (40 CFR Part 33) require that bid

documents include a complete statement of the work

to be performed, including design drawings,

specifications, and performance schedule. They

should also include the terms and conditions of the

contract to be awarded, including payment and

delivery schedules, and a clear explanation of the

bidding procedures and evaluation process. The

statement of work and detailed plans and

specifications represent your order for work to the

contractor. They must be carefully crafted to tell all

potential bidders the complete story of what you will

be expecting from them.

The financial and administrative aspects of the bid

documents should be carefully reviewed. The

contract must specify the method and procedure for

payment. You can avoid the potential for contractor

claims by stating clearly in the contract documents

how often and through which means the contractor

will be paid.

* * * * * * * * * * * * * *

TIP: Contract specifications should be ofa performance

nature, stating what is to be done, but not how it is to be

done. This leaves the potential contractors the freedom

to plan the day-to-day operation in whatever way they

feel is best, while you still have a control over the exact

character ofthe final product.

• Advertising for bids: In addition to the EPA

regulations, State laws may specify some minimum

requirements for advertising the bid. You should

meet this minimum, and it is generally to your

advantage to exceed it. Advertisements should be

placed in the local newspaper, any newspaper that

serves nearby cities, and any newspaper that is

known to be read by construction contractors (e.g., a

journal of commerce). Bid documents should be

provided to any potential bidder who responds to the

advertisement.

**************

TIP: You should hold a pre-bid conference two or three

weeks after the advertisements have appeared in order to

answer questions about the bid documents. Attendance

at this conference is recommended for anyone who

wishes to submit a bid, so that all bidders receive the

same information. The minutes ofthe conference should

be made available to all bidders. Similarly, ifyou or your

engineer answer questions about the bid documents over

the telephone, you should send letters summarizing all

questions and answers to all potential bidders.

• Evaluating bids and awarding the contract: Your bid

documents and advertisement must state a specific

date, time, and place for bids to be delivered. You

should open them at the advertised time and place

and read the bids to all present. This should be your

last public statement until you are ready to award the

contract. Your next task is to work with your

engineer to determine the "lowest responsive and

responsible bidder." "Responsive" bidders are those

who bid the job in conformance with the bid

documents, meeting the specified schedule,

indicating acceptance of contract provisions, stating a

firm price, accepting responsibility for project

quality, and so forth. "Responsible" bidders are

those who indicate that they have adequate staffing,

equipment, and experience to complete the job

correctly and on time. Your bid documents should

I
I

state clearly any definitive criteria you will use to

judge responsibility, using measures such as years of

experience in similar jobs of the person who will be

primarily responsible for the job, references from

other communities for which the contractor has done

work, and equipment owned or leased by the

contractor. Once you have determined each bidder's

responsibility and responsiveness, you award the

contract to the bidder who submits the lowest total

price of all those who meet both standards.

THE PROJECT BUDGET

Once the construction contract is awarded, the

community is able to prepare a final project budget for

the construction period. (A preliminary estimate should

have been developed in your facility plan or annual

capital budget.) It should cover all project-related

resources and outlays from the time the construction

contract is signed until permanent financing is secured.

A project budget is a plan of how the community will

raise funds for the project and how it will spend them to

reach the goal of a completed facility. It is, therefore, the

key planning and control document for the rest of the

process. The chief administrator and finance director

will prepare two budget breakdowns - one for inflows,

or "sources," of funds and one for outlays, or

"uses." Note that the terms sources and uses include

more than the traditional budget classifications of

"revenues" and "expenditures;" they also include

proceeds from debt financing and repayment of debt

principal. This approach gives a more complete picture

of the financial transactions relating to the project and

assists in cash-flow planning. The sources and uses

budgets should each be further broken down into

budgets for those items that are eligible for EPA grant

funding and those that are not. For example, EPA may

not pay for solutions to aesthetic problems that raise the

cost of the project, costs of furnishings, bond issuance

costs, and so forth. Exhibit 6 is a sample project budget.

The sources budget should list a forecast of revenue

from all sources that will be used to pay for the

construction cost of the project as well as items that are

not technically revenue, such as proceeds from shortterm notes. Note that Exhibit 6 separates true revenues

from other sources of funds. Typical sources include

connection fees, EPA and State grants, proceeds from

notes, proceeds from permanent financing, interest on

cash balances, and contributions from capital reserve

funds. For some sources, you will be able to budget very

accurately (e.g., EPA grants and capital reserve

contributions). For others, such as interest earnings and

connection fees, a very conservative "best-guess"

estimate will be required. Note that many communities

are authorized to sell both notes and bonds at a discount

from their face value so the community may receive less

in proceeds than expected. One community relied on its

engineer's estimate of the note discount and received

considerably less than it budgeted. Your financial

advisor should help estimate all sources and uses relating

to debt issuance.

**************

TRAP: One common cause ofshortfalls during

construction is overly optimistic budgeting. This is

particularly true in the sources side, where you must

anticipate future developments (i.e., number of

connections, interest earnings, etc.). Communities that

have run out offunds in the construction phase have

often been guilty ofoptimistic budgeting, particularly in

these items:

- interest earnings during construction,

- proceeds from short-term financing,

- items eligible for EPA grant funding,

- costs ofissuing debt, and

- construction costs.

Once total sources of funds are identified, each source

should be divided between funds to be used for EPA

eligible costs and funds for ineligible costs. Eligible

costs are those that may be paid for in part with an EPA

grant. Ineligible costs must be paid from local resources.

If your community is not receiving an EPA grant, there

is no need to make a distinction between eligible and

ineligible costs. At the end of this exercise, you will have

a detailed breakdown of total sources of funds and of

sources for eligible and ineligible costs.

Budgeting for uses of funds is often more difficult and

time-consuming than budgeting for sources. Many costs

of construction and financing may be overlooked and

they are often difficult to estimate or control.

Regardless, the general approach is quite similar. It is

important to develop an estimate of each cost item and

then determine whether it is eligible for EPA grant

assistance. This budget can be compared to the budget

for sources. These two budgets must balance, both for

total and for eligible costs. If uses exceed sources, either

the project must be reduced in cost or the community

must borrow more money.

Individual expenses, or uses, of funds are commonly

called "line-items." Some of the line-items that must be

included in the project budget are obvious; payments to

the engineer and to the construction contractor are

usually two of the largest. There may also be other lineitems relating to construction; for example, purchase of

land and payment of salaries of community employees

I
I 30

Exhibit 6

Project Budget

-I

Sources Eligible Ineligible Total

Permanent Financing

EPA Grant $ 3,500,000 $ 0 $ 3,500,000

State Grant 300,000 38,500 338,500

Capital Reserves 75,000 75,000 150,000

Interest Earnings 345,000 22,300 367,300

Bonds 2,495,000 98,000 2,593,000

Total Perm. Financing $ 6,715,000 $233,800 $ 6,948,800

Proceeds from Notes

Grant Antic. Notes $ 3,500,000 $ 0 $ 3,500,000

Bond Antic. Notes 2,300,000 78,000 2,378,000

Total Proceeds $ 5,800,000 $ 78,000 $ 5,878,000

Total Sources $12,515,000 $311,800 $12,826,800

Uses Eligible Ineligible Total

Permanent Outlays

Engineering $ 445,000 $ 12,300 $ 457,300

Construction 5,295,000 185,100 5,480,100

Proj. Mgmt.: In-house 24,000 3,000 27,000

Short-term Interest 360,000 9,700 369,700

Issuance Costs-Notes 12,100 3,200 15,300

Issuance Costs-Bonds 36,900 1,300 38,200

Contingency 542,000 19,200 561,200

Total Permanent Outlays $ 6,715,000 $233,800 $ 6,948,800

Repayment of Notes

Bond Antic. Notes $ 2,300,000 $ 78,000 $ 2,378,000

Grant Antic. Notes 3,500,000 0 3,500,000

Total Repayment $ 5,800,000 $ 78,000 $ 5,878,000

Total Uses $12,515,000 $311,800 $12,826,800
who will perform work. There are some related costs

that are frequently overlooked: building and other

permits, staff costs for project supervision, costs relating

to issuance of short- and long-term debt, such as charges

for bond counsel, financial advisor, interest expense,

bond ratings, and the like. The engineer and

construction manager should work together to develop a

comprehensive list of construction uses, while the

financial advisor can provide a list of budget estimates

for uses relating to financing. As in the case of sources of

funds, the budget for uses should be conservative. On

the uses side, this means estimating those costs that are

not known exactly a little higher than you expect.

**************

TIP: Always include a "contingency" line-item in your

budget ofuses offunds. There are llke1y to be change

orders in the construction process and other costs that

you either underestimated or failed to consider at all. At

the time ofpreparing a budget and cash flow forecasts, a

common contingency for construction projects is ten

percent.

THE CASH-FLOW FORECAST

Once the budget is completed, the community has a plan

and a means of controlling both incoming and outgoing

funds during the construction process. The budget will

be used during construction to give an idea of whether

the project is heading for trouble, with spending

exceeding the budgeted amount or revenues falling

short. A cash-flow forecast is another essential control

tool. Its purpose is to forecast the cash balances during

the project, helping to determine whether the project

funds and bank accounts will have adequate balances to

pay bills during the construction period. It also provides

a guide for investing fund balances during

construction.

Exhibit 7 represents a cash-flow forecast based on the

budget developed in Exhibit 6. It demonstrates how

available funds (sources) may be drawn down during a

typical construction project (uses). For each month, uses

are deducted from sources to demonstrate the

community's cash position.

The cash-flow forecasting process is best thought of as

breaking the detailed budget down further into a budget

for shorter time periods within the process. The major

difference is that the budget will not be in balance for

each time period; however, with good project and

financial planning, the balance will be positive until the

project is complete.

When preparing the budget, each source or use of funds

was broken down only into categories of eligible and

ineligible costs, to ensure that each category had a

balanced budget. In preparing the cash-flow forecast, it

may be necessary to break the sources and uses down

further by determining which project account or fund

they will affect. Without short-term financing, the

project may only require one account for all activities.

Short-term financing frequently complicates matters

further. Note indentures frequently require additional

accounts for items such as note interest payment,

payment of issuance costs, and so forth. Exhibit 7 shows

a simple fund breakdown in which construction is

accounted for in one fund and transactions relating to

the short-term notes in a second fund. The town's note

indenture requires that the EPA grant payments and

payments and proceeds from bonds be placed in the note

redemption fund, which may only be used to pay note

interest and principal. Note that this forecast assumes

the "contingency" item is spent uniformly over time.

While this is rarely the case, this method is more

conservative than assuming that the contingency will

either not be used at all or will not be used until the end

of construction.

**************

TIP: It is important to forecast and track the account

balances for every one ofthe accounts because you must

maintain a positive balance in each one. Ifthe

community overdraws the account for construction, it

wi11 be barred from paying construction bi11s from other

accounts by legal and investor restrictions. It wi11, in

effect, be unable to pay its contractor.

Once each source or use of funds is assigned to a specific

fund or account, it must also be broken down by time

period. Tracking cash flow by monthly periods is

generally adequate, particularly if most payments of

construction costs and interest costs are made regularly

each month. You should determine the total time the

project will take and layout a worksheet that lists every

month until completion. Next, estimate when each

source of funds will be received. For some, such as

proceeds from notes, there will only be one receipt and

for others (e.g., interest earnings, grant payments) there

will be more than one. Once again, conservatism is

important; it is best to assume that grant payments and

other sources will be delayed beyond the bare minimum,

thus leaving a margin for error. Uses of funds are also

broken down by time period. Payments to the engineer

and contractor may be estimated from the construction

schedule, payments of interest will be known once notes

are sold, and the financial advisor can help estimate the

timing of issuance costs.

31- II
I 32

Exhibit 7

Project Cash-Flow Forecast

Construction

Fund Month 1 Month 2 Month 3 Month 4 MonthS Month 6

Beginning Balance $ 0 $5,606,700 $5,007,700 $4,392,400 $3,665,100 $2,976,800

Sources

State Grant 0 21,000 24,000 30,000 33,000 35,000

Capital Reserves 150,000 0 0 0 0 0

Interest Earnings 1,000 43,000 40,000 35,000 29,000 22,000

Grant Antic. Notes 3,500,000 0 0 0 0 0

Bond Antic. Notes 2,378,000 0 0 0 0 0

Total Sources $6,029,000 $ 64,000 $ 64,000 $ 65,000 $ 62,000 $ 57,000

Uses

Engineering $ 125,000 $ 38,000 $ 35,000 $ 37,000 $ 32,000 $ 30,000

Construction 235,000 577,000 595,000 688,000 651,000 876,100

Proj. Mgmt.: In-house 2,000 2,000 2,300 2,300 2,300 2,300

Issuance Costs-Notes 15,300 0 0 0 0 0

Issuance Costs-Bonds 0 0 0 0 0 0

Contingency 45,000 46,000 47,000 65,000 65,000 65,000

Total Uses 422,300 663,000 679,300 792,300 750,300 973,400

Ending Balances $5,606,700 $5,007,700 $4,392,400 $3,665,100 $2,976,800 $2,060,400

Note Redemption

Fund Month 1 Month 2 Month 3 Month 4 MonthS Month 6

Beginning Balance $ 0 $

° $ 206,000 $ 602,200 $1,019,800 $1,472,800

Sources

EPA Grant 0 205,000 395,000 414,000 445,000 390,000

Interest Earnings 0 1,000 1,200 3,600 8,000 11,700

Bonds 0 0 0 0

Total Sources $ 0 $ 206,000 $ 396,200 $ 417,600 $ 453,000 $ 401,700

Uses

Short-term Interest 0 0 0 0 0 184,850

Bond Antic. Notes 0 0 0 0 0 0

Grant Antic. Notes 0 0 0 0 0 0

Total Uses 0 0 0 0 0 184,850

Ending Balance $

° $ 206,000 $ 602,200 $1,019,800 $1,472,800 $1,689,650
I

Exhibit 7

Project Cash-Flow Forecast (Continued)

Construction Fund Month 7 MonthS Month 9 Month 10 Month 11 Month 12 Total

Beginning Balance $2,060,400 $1,395,100 $ 925,400 $ 499,200 $ 253,600 $ 132,600 $ N/A

Sources

State Grant 35,000 37,500 35,000 35,000 35,000 18,000 $ 338,500

Capital Reserves 0 0 0 0 0 0 150,000

Interest Earnings 18,000 10,100 7,100 4,000 1,800 1,600 212,600

Grant Antic. Notes 0 0 0 0 0 0 3,500,000

Bond Antic. Notes 0 0 0 0 0 0 2,378,000

Total Sources $ 53,000 $ 47,600 $ 42,100 $ 39,000 $ 36,800 $ 19,600 $6,579,100

Uses

Engineering $ 30,000 $ 35,000 $ 32,000 $ 33,300 $ 18,000 $ 12,000 $ 457,300

Construction 621,000 425,000 389,000 214,000 123,000 86,000 5,480,100

Proj. Mgmt.: In-house 2,300 2,300 2,300 2,300 2,300 2,300 27,000

Issuance Costs-Notes 0 0 0 0 0 0 15,300

Issuance Costs-Bonds 0 0 0 0 0 38,200 38,200

Contingency 65,000 55,000 45,000 35,000 14,500 13,700 561,200

Total Uses 718,300 517,300 468,300 284,600 157,800 152,200 6,579,100

Ending Balances $1,395,100 $ 925,400 $ 499,200 $ 253,600 $ 132,600 $ 0 $ N/A

Note Redemption

Fund Month 7 MonthS Month 9 Month 10 Month 11 Month 12 Total

Beginning Balance $1,689,650 $2,178,850 $2,520,850 $2,801,150 $3,059,250 $3,301,550 N/A

Sources

EPA Grant 476,000 321,000 258,000 234,000 217,000 145,000 3,500,000

Interest Earnings 13,200 21,000 22,300 24,100 25,300 23,300 154,700

Bonds 0 0 0 0 0 2,593,000 2,593,000

Total Sources $ 489,200 $ 342,000 $ 280,300 $ 258,100 $ 242,300 $2,761,300 $6,247,700

Uses

Short-term Interest 0

° ° 0 0 184,850 369,700

Bond Antic. Notes 0 0 0 0 0 2,378,000 2,378,000

Grant Antic. Notes 0 0 0 0 0 3,500,000 3,500,000

Total Uses 0 0 0 0 0 6,062,850 6,247,700

Ending Balance $2,178,850 $2,520,850 $2,801,150 $3,059,250 $3,301,550 $ 0 N/A
I 34

Once each source and use has been forecast by time

period, it is a relatively simple matter to forecast a cash

balance for each account at the end of each time period.

Simply add the beginning balance for the period to all

sources to be received during the period, then subtract

the uses for the period. It will be helpful in monitoring

cash flow to develop a summary table of the forecast that

only shows the forecast balance of each account at the

end of each month. Exhibit 8 is the summary table for

the forecast shown in Exhibit 7.

It is important to stop at this point to verify that the

cash-flow forecast shows positive balances in each

required fund until project completion. If not, the

community will have to locate additional resources.

PLANNING THE

OPERATING BUDGET AND

USER CHARGE SYSTEM

The basic techniques used to set up the project budget

and cash-flow forecast will also be useful in structuring

the operating budget for the completed facility. For

communities upgrading or expanding an existing system,

the rate increases or other sources of operating revenue

needed to cover the additional operating expenses and

added debt service costs can be considered during an

annual review of the existing operating budget. For new

systems, however, the operating budget for the

wastewater treatment enterprise fund will have to be

built from scratch. It is important that key elements of

the first year's operating budget be completed in the

pre-construction phase. With a good operating plan in

hand, changes in the cost and design of the project that

occur during construction can be monitored for their

effect on budgeted revenues and expenses, with ample

time to take corrective actions, if needed.

**************

TIP: For existing systems, an increase in rates prior to

starting construction can allow the community to

develop capital reserves, which can, in turn, be used to

reduce the amount oflong-term borrowing. If

construction ofyour project is expected to span several

years, you should plan a series ofrate increases so that

new charges are phased in gradually.

The first step in setting up an operating budget,

estimating expenses, can be prepared from work

completed earlier. The major expenses for the first year

of operation can be estimated from: (I) the expected

operation, maintenance, and replacement costs provided

by your engineer (see Chapter II) and (2) the expected

debt service for the bond issue estimated in the project

budget. All other expense items (e.g., contn:lctual

services, administrative costs, interdepartmental service

accounts, training, payments in lieu of taxes, etc.) should

also be identified and included in the operating budget.

The second step consists of developing reliable sources

of revenue that will match or exceed expected expenses.

The revenue plan should be flexible enough to meet the

requirements of users, local and State governments,

bond holders, and EPA (if grant-funded), while ensuring

self-sustaining operations of the completed facilities.

Typically, the chief source of operating revenue will be

from the collection of user fees. Other revenue sources

in common use include property taxes, connection fees,

inspection fees, system development charges, and

dedication of special utility or sales taxes to the

wastewater treatment fund.

**************

TIP: Development ofa revenue plan should begin at

least one year prior to project start-up to ensure that a

rate structure is in place before bonds are sold. Potential

investors and bond rating agencies wl11 be favorably

impressed by this indication that the community has

provided for an adequate revenue base.

As a prerequisite to receiving an EPA grant, EPA

regulations specify that you must develop a user charge

system designed to produce adequate revenues to pay all

costs of operation and maintenance (including

replacement). Although the revenue plan must include

collections for covering expected capital outlays and

debt service of outstanding bonds and notes, EPA

regulations do not require you to use any particular

method or basis for assessing charges to recover the cost

of capital items.

An EPA-approved system of user charges must provide

that each user or user class pay its proportionate share of

the operating costs, based on the quantity and quality of

the wastes discharged to the sewer system. EPA

regulations further provide that you establish an

adequate financial management system that will

accurately account for revenues and expenses, based on

an annual operating budget. (See Chapter IV for further

discussion on establishing accounting systems.) The

regulations also require that you inform each user

annually, in conjunction with a regular bill, of the rates

established for the year and the portion that is

attributable to operating expenses. You will have to

adopt the user charge system through passage of an

ordinance or other legislative enactment.
Exhibit 8

Summary of Cash Balances

Forecast of Ending Cash Balance

Month Construction Note Total

Fund Red. Fund

1 $5~606~700 $ 0 $5~606~700

2 5~007~700 206~000 5,213~700

3 4~392~400 602,200 4~994-!600

4 3~665~100 1~019~800 4~684~900

5 2~976~800 1~472~800 4~449~600

6 2~060~400 1~689~650 3~750~050

7 1~395~100 1~178~850 3~573~950

8 925~400 2S20~000 3~446~250

9 499~200 2~801~150 3~300~350

10 253~600 3~059~250 3~312~850

11 132~600 3~301~550 3~434~150

12 0 0 0

35 !!I
I 36

In order to meet the EPA requirements for user charge

systems and to develop a revenue plan, you will need to

undertake a comprehensive rate study. The study should

consist of the following steps:

• Establish a rate study team. This group should

include representatives from the agency's

management, operation, planning, and finance

functions, as well as in-house or outside legal

counsel. An engineering or financial consultant

should be involved in the process along with inhouse staff.

• Establish billing collection processes. In an agency

that presently charges customers for water or sewer

services, this step will be limited to ensuring that the

existing process will handle the new user charge

structure. In a new agency, or one with no

experience with user charges, at least two additional

months should be allowed to establish accounting

records, print bills, and develop a collection system.

• Determine the annual costs of the system. The goal

of this step is to determine how much revenue must

be generated through charges. The costs are in two

distinct areas. One is the annual cost of operating and

maintaining the facility (e.g., salaries, chemicals,

parts, and electricity). The second area is the cost of

annual principal and interest on the borrowing for

the treatment plant, as well as the costs related to any

prior bonds or loans.

• Allocate the total amount of revenue to be raised

from user charges for various user classes. This step

requires an estimate of system loadings in terms of

both flow and strength. From these estimates, unit

charges can be developed and the charge to each user

class established.

* * * * * * * * * * * * * *

TIP: Throughout the process ofdeveloping a revenue

plan and user charge system, you should hold public

hearings, establish advisory groups, seek out newspaper

or television coverage and use other appropriate methods

ofpublic involvement to keep your community wel1-

informed. Citizens who are convinced about the

importance ofadequately financing wastewater

treatment can be a positive force in mitigating any

adverse public reaction to rate increases.

The user charge study may take a year or longer to

complete, especially if new revenue collection systems

must be incorporated. EPA regulations require that the

user charge system be approved by EPA prior to grant

award and enacted before the facilities are placed in

operation. (See Chapter V for a description of this task.)

A source of guidance on setting user charges is EPA's

User Charge Guidance Manual [or Publicly-Owned

Treatment Works.

CONCLUSION

Exhibit 9 reviews the major financial activities in the

pre-construction phase. With adequate short-term

financing, a plan for long-term financing, a strong

construction contract, a project budget and a cash-flow

forecast, an operating budget, and a user charge system

all in place, you are ready to proceed with building the

facility itself. You have already laid the foundation with

careful planning and have built a strong framework with

the pre-construction financing steps. You have now

moved into scoring position and have an excellent

chance to score a run.

II
Exhibit 9

37 II

Matrix of Functions Performed in

the Pre-Construction Phase

* * * * * * * *

What is Done Who Does it When To and With Whom

SHORT-TERM Finance While selecting Bond Counsel

FINANCING Officer a construction Financial Advisor

contractor

DESIGNING Finance When short-term Bond Counsel

BOND ISSUE Officer financing proceeds Financial Advisor

are received

CONSTRUCTION Purchasing When project Engineer

CONTRACT Agent design is Contractors

complete

PROJECT Finance When construction Financial Advisor

BUDGET Officer contract is

signed and shortterm financing is

complete

CASH-FLOW Finance When project Financial Advisor

FORECAST Officer budget is

completed

PLANNING THE User charge Begin prior to Submit

OPERATING study team initiation of recommendation

BUDGET construction to legislative

finish prior body

to facility

operation

OVERALL Project Throughout the All team members

PROJECT Manager project involved in this

MANAGEMENT phase
I

CHAPTER IV

Financial

management

during the

• constructIon

phase:

advancing

to third

Your community is now ready to begin construction,

having completed the important preliminary steps. Good

financial management is just as important during

construction as in the previous stages. If you allow

financial control to slip now, you will be left stranded at

second base at the end of the inning.

During construction, there are five major financial

activities that make up the subparts of this chapter:

establishing accounting systems, recording transactions,

investing construction funds, managing the contract, and

monitoring project progress. While most of these

functions are ongoing, they are listed in the order of

likely precedence.

ESTABLISHING

ACCOUNTING SYSTEMS

Establishing and maintaining adequate accounting

systems is important in any local government, but a

community must be particularly careful to do so when

managing a large construction project, due to the

potential for loss of funds or a poor product.

The most important element of an accounting system is

a set of controls. Financial controls exist for four

important reasons. First, they assist in error detection

and correction. Second, they help ensure that resources

are conserved and used only for the construction

process. Third, they help the community meet Federal

and State requirements for careful stewardship of grant

monies. Fourth, they play an important part in

documenting the project for purposes of auditing.

A system of internal controls is based on premises that

are simple, but often difficult to carry out, particularly

in a small community. The premises are:

• responsibility for initiating, recording and reporting

financial transactions should be centralized in one

department in order to strengthen control over

resources;

• accounting information should be contained in a

unified record-keeping system that allows for easy

access to information;

• consistent procedures and standards should govern

all financial records and reporting;

• accounting duties should be assigned so that no one

person is responsible for one transaction from

beginning to end;

• operational employees should not have any

accounting duties;

39

-II
I 40

• important accounting documents should require the

signature of a responsible financial official; and

• records should be regularly reconciled and corrected

as necessary.

EPA regulations require that communities receiving

Federal grants maintain adequate systems of financial

control as a condition of grant receipt. Specific

requirements include accurate, current and complete

disclosure of all grant-related transactions; complete

records; control over property and funds; comparison of

budgets to actual results; and procedures to determine

allowability of costs. In addition, the accounting system

must be designed to provide adequate financial

management of the facility once the project is complete.

**************

TRAP: The five most common accounting problems for

communities receiving grants are:

- failure to separate eligible and ineligible costs;

- failure to segregate costs between different grants;

- failure to develop written procedures for grant

accounting;

- failure to justify and record Federal

reimbursements;

- failure to maintain documentation supporting

payment requests.

While it is beyond the scope of this handbook to

prescribe a complete accounting system, it is possible to

recommend some steps that a community may take to

improve its ability to account for an EPA grant. Good

grant accounting procedures include the following:

• The finance officer should establish a separate ledger

account for the project in the community's books.

Your accounting system probably already divides

revenues and expenditures by fund, department, or

other organizational division. The finance officer

should determine how best to establish a set of

accounts so that project transactions are recorded and

reported separately from other transactions. This will

allow your community to track revenue by source

and expenditures by line item for the project.

• The finance officer should assign specific individuals

to account for all project-related transactions. One

person might be responsible for requesting EPA

reimbursements, another for making payments to

contractors, and so forth. You should also assign one

person to sign all project-related forms, including

checks, reimbursement requests and the like.

• The finance officer, in conjunction with the public

works director, should develop written procedures

for the project. Procedures should cover the

following topics:

- what documentation and approval are required

before paying the contractor;

- how retainage will be handled;

- when requests to EPA for reimbursement will be

made and by whom; and

- what reports must be prepared and how often.

• The finance officer should develop forms and reports

to account for grant activites, including comparisons

between budget and actual performance, cash-flow

tracking, authorization to make payments, etc.

• The finance officer should establish a system within

the community's payroll structure to ensure that any

staff time that is to be charged to the project is

adequately documented. ThiS generally requires a

timesheet on which an employee breaks down his or

her daily activity by hours spent on the project

versus hours on other activities. For project-related

activities, the employee should also state briefly what

he or she did during the charged time. You should

also set up a system to charge a pro-rated share of

employee benefits and payroll taxes to the project. If

work done by employees (often called "force account

work") is expected to exceed $25,000, the State

reviewing agency must approve it as a condition of

receiving an EPA grant.

• The finance officer should make sure that everybody

who will be working on accounting for the project

understands what costs are not eligible for EPA

reimbursement, then set up a separate sub-account in

the project accounting system to record all ineligible

costs.

• The finance officer should establish project files and

make sure that all documents relating to the project

are filed by document type and then chronologically

within each type of document. This will be necessary

if there are questions about reports generated when

the EPA auditors arrive.

• The finance officer should establish an inventory of

all property and equipment purchased as part of the

project.

For additional information, refer to the EPA brochure

entitled, "What to do Before and After the Auditors

Arrive." There are a number of other steps you can take

at the outset of a project to make it easier to account for

and control the project. The finance officer should take

responsibility for determining what steps are necessary,

assisted by an outside auditor if necessary.

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I

* * * * * * * * * * * * * *

TRAP: One common mistake made by communities

with construction projects is using separate bank

accounts to keep track ofdifferent types ofmoney (e.g.,

grant funds vs. local funds, eligible vs. ineligible items,

etc.). This should be avoided at a11 costs and done only

when note or bond indentures require separate bank

accounts to secure the debt obligations. Multiple

accounts are expensive to maintain and to balance and

they also promote accounting errors. You should

develop an accounting system that ensures that money is

tracked and credited to the right ledger account instead

ofopening new bank accounts.

PROCESSING AND

RECORDING TRANSACTIONS

With the accounting system in place and construction

underway, the finance office will settle into a routine of

accounting for the project along with its other duties. As

financial events take place, the finance office will use the

accounting system to ensure that all financial

transactions are processed, recorded in the books and

summarized in reports. This discussion will summarize

the processing and recording functions by describing

how some of the more common financial events should

be handled.

When notes are sold:

The accounting system must account for the receipt of

proceeds. First, the note indenture should be read

carefully by the finance department so that proceeds are

deposited properly. Then the proceeds should be placed

in the appropriate bank account quickly; interest

earnings for a day or two on a deposit of this size can be

significant. The deposit should be recorded in the cash

receipts journal, properly divided between the subaccounts of eligible costs. The cash receipts entry should

. be backed up by the community's standard form for

receipts, along with a copy of the note indenture and a

statement from the underwriter of how the proceeds

were calculated.

When employees charge time to the project:

Each employee working on the project, whether as

construction laborer or construction manager, must

enter project-related hours on a timesheet and turn it in

at the time specified by payroll policies. The timesheet

should be signed by the employee's immediate

supervisor; the construction manager should also sign to

verify time spent on the project. When paychecks are

written, the total amount charged by all employees (both

in direct labor and in benefits and payroll costs) should

be entered in the payroll ledger for the project, once

again split between eligible and ineligible items. All

timesheets that charge time to the project should be filed

chronologically along with calculations of benefits

expenses, for review by EPA's auditors.

When the contractor requests partial payment:

You should develop a form that the contractor uses to

request payment. When the request is received, it should

be verified by both the engineer and the construction

manager. The payment request should reflect the

retainage allowed by the contract. You may wish to issue

a check to the contractor as soon as payment is

approved, since contractors frequently experience cashflow difficulties. The check should be recorded in the

check register in the project account, broken down into

eligible and ineligible costs. You should also maintain a

log that keeps a running balance on each construction

contract, listing the original amount, additions due to

change orders, subtractions due to payments, and the

current balance.

When the community purchases equipment:

When an invoice arrives for equipment to be used in the

project, the engineer and construction manager should

both verify the necessity of the equipment, that it

arrived, and that the invoice is correct. A check may

then be written and recorded in the check register. You

should also establish an inventory card for the

equipment, listing its purchase price and date, location,

equipment identification number, and expected useful

life (for calculating depreciation). All inventory cards

should be filed for audit. Once a year, the card should be

used to conduct a physical inventory to see if all

equipment is still in use.

When users pay connection fees:

It is not normally necessary to physically segregate

connection fee payments from other monies. Instead,

they must be recorded in the project account in the cash

receipts journal on a separate revenue line. Revenue and

expenditure sub-accounts in the project accounting

records should match those in the project budget for

easy budget control. Receipts should be issued for all fee

payments and, if connections are mandatory, you should

maintain a list of all customers who must pay fees, to be

marked "paid" when money is received. You should also

be able to determine that connection fees are used for

proper purposes. For example, if connection fees are

limited to building one sewer line, you must be able to

show that you spent at least as much on that line as you

received in connection fees.

4L II
I 42

When the community invests excess construction funds

(coming from its own sources--not federal sources):

Investments should be made only after soliciting quotes

by telephone from more than one bank or institution.

You should invest with the institution that pays the

highest rates and provides a completely secure

investment. A record should be kept of the rate quoted

by each institution. An entry should be made in bank

account records to reflect movement of cash from the

checking account to an investment instrument. When

the investment matures, the payment of interest must be

verified against the quoted rate. An entry should be

made to return the principal and interest to the checking

account. The interest should be recorded as revenue in

the cash receipts journal.

**************

TIP: Note indentures and good fmancial management

practices both require that interest be credited to the

account from which the principal was drawn. Ifan

investment is made from funds restricted to repayment

ofnotes, the interestrevenues should also be credited to

that account.

When the community requests reimbursement

from EPA:

It is in your best interest for cash-flow purposes to

request payment from EPA on a monthly basis for costs

actually incurred. An employee, perhaps the

construction manager, should be assigned the

responsibility of initiating this process at the same time

every month. The first step is to determine total costs

during the month that are eligible for reimbursement.

The best way to accomplish this is to record in the

eligible costs sub-account in the check register all those

incurred costs that have already been paid by EPA. It is

then a relatively simple matter of requesting

reimbursement for those incurred costs that are not

marked as paid. These should be totalled and EPA's

standard form for reimbursement (EPA Form 271) filled

out and signed by either the finance officer or the chief

administrative officer.

Copies should be filed and sent to the construction

manager. Once the reimbursement is received, it should

be entered in the cash receipts journal and all

reimbursed expenditures so marked in the check

register. You must also maintain a log of reimbursement

requests, listing the date and amount of each request, as

well as the date the reimbursement is received.

To summarize, project transactions should be recorded

just as any community with a good accounting system

records all transactions. As long as you maintain a

complete set of accounting records (general ledger, cash

receipts journal, check register, payroll system, chart of

accounts and so on), make sure that all project-related

events are recorded in the proper accounts separate from

all other activities, maintain records on the accrual

basis of accounting, and regularly generate and review

reports, you should not have any great difficulty with

project accounting.

INVESTING

CONSTRUCTION FUNDS

Note proceeds should be invested by the finance officer

in a manner that: (l) recognizes the need to meet

expenses identified by the construction draw-down

schedule; (2) provides a good (current market) return on

the investment; and (3) ensures preservation of the

principal amount invested. A conservative approach to

the funding demands identified in the draw-down

schedule is needed to permit earlier disbursements to

cover unanticipated expenses or to pay contractors if

construction is running ahead of schedule.

Speculative investments, which place the principal

amount at some risk, have no place in municipal finance

generally and are particularly inappropriate when it

comes to investment of borrowed funds. The challenge

facing the issuing government is to identify a strategy

that both protects the principal of the borrowed funds

and offers a fair market return on investment.

Remember that your goal is to build a wastewater

treatment facility, not to chase every last dollar of

interest earnings.

A variety of investment alternatives are available that

satisfy the needs identified above. The section below

provides a comparison of some of the most common

investment alternatives and indicates the advantages and

disadvantages of each. State statutes and local charter

provisions vary concerning authorized use of note

proceeds, so consultation with bond counsel is important

before any investment decisions are made.

U.S. Treasury Securities:

Backed by the full faith and credit of the United

States government, these securities represent the most

secure investment option for communities. Treasury

bills are available in maturities of up to one year; notes,

in maturities of up to 7 years; and bonds, in maturities

of up to 30 years. Because Treasuries are secured by the

absolute pledge of payment by the U.S. government,

these investments carry lower interest yields than many

other securities. A loss is possible if you are forced to sell

Treasury investments prior to the stated maturity date.
In general, you should avoid investments that may have

to be sold prior to maturity.

U.S. Government Agency Issues:

A variety of U.S. government agency issues are available

that have characteristics similar to Treasury securities.

The yield on agency issues is generally higher than on

Treasury securities because they are not backed by the

full faith and credit of the U.S. government. Again, the

potential for market loss is possible if these securities are

sold prior to maturity. The market for agency issues is

occasionally volatile and unpredictable.

Certificates of Deposit:

Certificates of Deposit, or CDs, are receipts that

represent a deposit of funds at a commercial bank or

savings institution. The CD specifies a maturity date

and interest rate to be paid. Security is provided by the

quality and extent of collateralization, which is the

cash and securities that the institution pledges as

security against the community's investment.

Uncollateralized CDs are secured by the

creditworthiness of the depository institution. (Most

States require that CDs be collateralized.) As with

Treasury securities, a market loss may result if sold prior

to maturity.

Repurchase Agreements:

A repurchase agreement is an agreement between a

community and a bank wherein the community buys a

security from the bank at a specified price and the bank

simultaneously agrees to repurchase the security at a

future date and price. Since security of a government's

investments is a dominant consideration, all investments

in repurchase agreements should be conducted in such a

way that: (I) the community takes physical custody of

the instrument; and (2) the investment be more than

100% collateralized to guarantee the security of the

principal invested. The difference between the price the

community pays for the security and the price it receives

'for re-sale of the security to the bank represents its

return on investment. Security is provided by the

creditworthiness of the bank in the transaction.

Repurchase agreements offer the advantage of

considerable flexibility, but you should require a

contract that protects your interests (as indicated above)

in the event of interest rate fluctuations.

Savings and Checking Accounts:

Communities may open bank accounts with note

proceeds in much the same way individuals handle their

own funds. This option provides maximum liquidity

(ability to convert the investment to cash) and is insured

up to the limits of the Federal Deposit Insurance

Corporation (FDIC). The Federal Savings and Loan

Insurance Corporation (FSLIC), a division of the

Federal Home Loan Bank Board, provides insurance for

deposits made in Federal Savings and Loans Banks. The

interest yield is typically lower than what is available

from other investment alternatives. Where possible, you

should write checks on an insured, interest-bearing

checking account such as a "NOW" account, so that all

construction funds earn some interest.

Pooled Investment Programs:

Many counties and States have pooled investment

programs that offer communities immediate liquidity

and a better interest yield than is available from savings

or checking accounts. The security provisions of local

government investment pools (LGIPs) vary

considerably. Most LGIPs invest in U.S. government

securities, CDs, and repurchase agreements. The finance

officer is advised to exercise caution in the choice of this

investment alternative for the investment of construction

funds.

* * * * * * * * * * * * * *

TIP: In a falling interestrate environment, the interest

yields in an investment pool are generally higher than

those available through independent investing. This is

because the interest yield in the pool is determined in

part by securities that were purchased when rates were

high.

MANAGING THE CONTRACT

Having developed a complete construction contract in

the pre-construction phase, you must devote your efforts

during the construction phase to making sure that the

contract is followed. Three essential techniques available

to assist in this process are appointing a construction

manager, establishing strong reporting requirements for

the engineer, and maintaining control over change

orders.

The construction manager and project manager should

be employees of the community. For smaller

jurisdictions which do not already employ individuals

with a range of construction and engineering experience,

the construction manager will probably be a contract

employee whose relationship with the community will

cease with the formal acceptance of the construction

work. Whatever the case, the employee who does this

job must be allowed to devote enough time to do it

properly. A major construction project may require at

least one-half, if not all, of the construction manager's

working time.

43 II
I

44

Ideally, the construction manager should have a good

understanding of both construction techniques in

general and of wastewater treatment systems in

particular. If the community currently has an operating

treatment system, a plant manager or public works

director would be the ideal choice for this job.

**************

TIP: Ifyour treatment system employees are unionized

and a supervisor has negotiating experience, appoint that

person as the construction managerj the talents required

are strikingly similar.

You must give the construction manager explicit

authority to represent your community in all dealings

with the prime contractor and the engineer; a formal

action by the legislative body is a good idea. If the

manager does a good job, he or she will occasionally

ruffle the feathers of both the engineer and the

contractor, who may be tempted to find a more

sympathetic ear elsewhere on the staff. The governing

body should state when appointing the manager that all

communication between the community and the

contractor is to be through the manager and that all

employees should follow this rule. It will help ensure

that the contractor does not receive conflicting

instructions.

The construction manager's task is to monitor progress

toward completion. This person must therefore be

familiar with the facility design, the construction

contract, and the schedule, as well as EPA regulations

that govern construction. The manager should meet

regularly (at least every two weeks) with the engineer to

discuss progress and problems and should regularly

inspect the work and keep in touch with the contractor.

It is a temptation to leave this responsibility to the

engineer, but remember that the community, not the

engineer, has to live with the final product and pay debt

service and all operation costs.

When either the engineer or contractor submits requests

for partial payment, the construction manager should

review and approve them before they are paid. The same

procedure applies to recommendations from the

engineer that the community buy a piece of equipment

for the project. The manager should also review and

approve any community employees' timesheets that

show they worked on the project. Any recommendations

for change orders received from the engineer should be

routed through the construction manager for his or her

recommendation before they are approved by the

legislative body.

The construction manager should approve the quantities

and progress on the contract for payment but should not

be involved directly in the payment to the contractor

because this would violate an important rule of internal

controls, as described later in this section. Second, the

manager should be required to make progress reports to

the community'S appointed and elected officials. As a

general rule, the manager should be expected to report

routinely to the chief administrative officer and to the

legislative body on a monthly basis.

Good reporting from the engineer is the second tool

available to the community to ensure successful

construction. The engineer should regularly inspect the

construction site and keep apprised of developments to

the greatest extent possible. The engineer should also

report by telephone or in person to the construction

manager at least weekly. The engineer should prepare a

written report on the project at least monthly. That

report should summarize all progress to date, especially

that accomplished in the past month. The engineer

should also report on what is expected to be

accomplished in the next month, with particular

attention to any possible problems or potential requests

for change orders. The report should also provide an

update on progress as measured against the original

construction schedule.

For each event on the schedule that is completed, the

actual completion date should be entered next to the

scheduled date. For future events, the engineer should

report on any itemsthat are not expected to be

completed on schedule, giving a reason and a new

estimate of the completion date. The engineer's report

should be forwarded to the construction manager for

written comment and then reviewed by the chief

administrative official and the legislative body.

As mentioned in Chapter III, some change orders may

be necessary during construction. This could occur

when a specified component is not available in a

reasonable time frame, or when bedrock is uncovered in

digging the foundation for the new trickling filter

(although you should still ask the engineer why the

specifications required an unprocurable part and why a

soil sample didn't show the bedrock). Other change

orders may be necessary, and may represent a chance to

save money or make an improvement to the original

design. You must carefully consider all change orders,

particularly those which represent increased costs.

The key element in deciding if a change order is needed

is whether a significant change ill conditions has

occurred (and could not have been reasonably
I

anticipated by an experienced engineer and contractor).

If so, you should accept the change order and carefully

negotiate a price; change orders can be used by

contractors to increase their profit margin. All change

orders should be justified in writing by the contractor,

approved by the engineer and construction manager, and

formally approved by the legislative body. If your

community receives an EPA grant, some change orders

may require State or EPA approval. EPA provides

detailed information on change orders in its publication

Management ofConstruction Change Orders: A Guide

for Grantees.

MONITORING

PROJECT PROGRESS

The finance officer should generate a complete set of

project financial reports on a monthly basis. The goal

should be to have all reports completed by the tenth day

of the following month. The reports should include:

• a project balance sheet;

• a report of contract status;

• a report of reimbursement status;

• a report of budgeted and actual sources and uses; and

• a report of forecast and actual cash balances.

The balance sheet compares the assets and liabilities of

the project accounts. Assets are things of value that

belong to the project, typically cash and investments,

grants receivable, and the value of construction in

progress. Liabilities are amounts owed by the project,

including repayment of notes, payroll, invoices payable,

and so forth. The balance sheet simply compares assets

and liabilities and tells whether the project is solvent.

The report of contract status should simply summarize

financial transactions (change orders, payments, etc.)

regarding the construction contract for the previous

month along with a summary of all previous contract

'payments and the balance remaining on the contract.

* * * * * * * * * * * * * *

TIP: It is a good idea to compare this report with the

engineer's monthly progress report to determine if

payments are closely related to actual progress. Ifnot,

future requests for payment should be more careful1y

reviewed.

The report of reimbursement status shows all grant

reimbursement activities for the previous month and

should show for the entire project the total of eligible

work completed, grant reimbursements requested, and

grant reimbursements received. It may also be useful for

cash-flow planning purposes to calculate the average

delay from request to receipt of reimbursement. If

reimbursements are behind schedule, you must learn the

cause of the delay and address the problem. Check the

activities of your staff in completing and submitting the

fonns to EPA. Only after you have established that your

requests have been timely and accurate should you seek

information from EPA on the status of your

reimbursements.

The report of budget and actual sources and uses is of

critical importance to good project management. It

indicates whether the project is headed for trouble

before it is completed. Exhibit 10 is a sample budget

report based on the budget shown in Chapter III. It is

useful to point out that while the "project-to-date

actual" ($6,797,075 in the fourth column) is below the

project-to-date forecast ($7,241,800 in the next column)

by approximately $450,000, the corresponding uses of

funds "actual" is Gelow the forecast by approximately

$900,000. Thus, the situation is under control for the

moment, but vigilence must never cease.

If the project-to-date actual expenditures are greater

than the forecast expenditures, you must take immediate

action to identify and remedy the problem. Regular

monitoring of these figures should identify areas of

concern before the excess expenditures become serious

cash-flow problems. Options to remedy this situation are

described below.

Note that Exhibit 10 uses the same categories of sources

and uses as the budget and is laid out in the same basic

format. It shows the original budget for each item, the

amount received or spent in the current month, the

amount received or spent for the project to date, and the

amount still to be received or spent. When the

community has done a monthly cash-flow forecast, it can

also include a comparison of the amount actually

received or spent through the report date to the amount

that was expected to be received or spent. This gives a

better picture of the budget status than the rest of the

budget report because it recognizes that many sources

and uses do not flow uniformly throughout the project.

The legislative body and the chief administrative official

should expect some explanation of the budget report,

covering the major variances between budget and actual,

the reasons for the variances, and the anticipated impact

of each. The chief financial official should prepare this

report, usually after discussing each item with the

construction manager. The project manager should also

recommend any changes that will be necessary to finish

the project within budget or, if this is impossible, he

should ask the finance officer to locate additional

resources.

45

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I 46

Exhibit 10

Budget Report

As ofEnd ofMonth 4: Total Project

Forecast Percent

Month Project- Project- vs. Actual Remaining

Four to-Date to-Date Favorable/ Remaining to be

Sources Budget Actual Actual Forecast (Unfavorable) Balance Received

Permanent Financing

EPA Grant $ 3,500,000 $312,455 $ 543,000 $1,014,000 ($471,000) $ 2,486,000 71.03%

State Grant 338,500 61,000 91,000 75,000 (16,000) 263,500 77.84

Capital Reserves 150,000 0 150,000 150,000 0 0 0.00

Interest Earnings 367,300 28,067 106,209 124,800 18,591 242,500 66.02

Bonds 2,593,000 0 0 0 0 2,593,000 100.00

Total Perm. Financing $ 6,948,800 $401,522 $ 890,209 $1,363,800 ($468,409) $ 5,585,000 80.37%

Proceeds from Notes

Grant Antic. Notes $ 3,500,000 $ 0 $3,527,000 $3,500,000 $ 27,000 $ 0 0.00%

Bond Antic. Notes 2,378,000 0 2,379,866 2,378,000 1,866 0 0.00

Total Proceeds $ 5,878,000 $ 0 $5,906,866 $5,878,000 $ 28,866 $ 0 0.00%

Total Sources $12,826,800 $401,522 $6,797,075 $7,241,800 ($439,543) $ 5,585,000 43.54%

Forecast Percent

Month Project- Project- vs. Actual Remaining

Four to-Date to-Date Favorable/ Remaining to be

Uses Budget Actual Actual Forecast (Unfavorable) Balance Received

Permanent Outlays

Engineering $ 457,300 $ 41,320 $ 268,000 $ 235,000 ($ 33,000) $ 222,300 48.61%

Construction 5,480,100 235,690 1,356,799 2,095,000 738,201 3,385,100 61.77

Project Mgt.: In-house 27,000 2,346 9,105 8,600 ( 505) 18,400 68.15

Short Term Interest 369,700 0 0 0 0 369,700 100.00

Issuance Costs-Notes 15,300 0 12,466 15,300 2,834 0 0.00

Issuance Costs-Bonds 38,200 0 0 0 0 38,200 100.00

Contingency 561,200 0 0 203,000 203,000 358,200 63.83

Total Permanent Outlays $ 6,948,800 $279,356 $1,646,370 $2,556,900 $910,530 $ 4,391,900 63.20%

Repayment of Notes

Bond Antic. Notes $ 2,378,000 $ 0 $ 0 $ 0 $ 0 $ 2,378,000 100.00%

Grant Antic. Notes 3,500,000 0 0 0 0 3,500,000 100.00

Total Repayments $ 5,878,00()' $ 0 $ 0 $ 0 $ 0 $ 5,878,000 100.00%

Total Uses $12,826,800 $279,356 $1,646,370 $2,556,900 $910,530 $10,269,900 80.07%
Exhibitll

Cash-Flow Report

End of Month 4

Construction Fund

Month Forecast Actual Over (Under)

Ending Ending Forecast

Balance Balance

1 $5,606,700 $5,547,098 ($ 59,602)

2 5,007,700 5,436,791 429,091

3 4,392,400 5,343,670 951,270

4 $3,665,100 $4,605,598 $940,498

Note Redemption Fund

Month Forecast Actual Over (Under)

Ending Ending Forecast

Balance Balance

1 $ 0 $ 0 $ 0

2 206,000 0 ( 206,000)

3 602,200 0 ( 341,000)

4 $1,019,800 $ 545,107 ($474,693)

47 -
I 48

Exhibit 11 is a sample of a cash-flow report. Note that,

once again, this report is based on the original cash-flow

forecast, using the same format. This report should

simply state the originally forecast cash balance at the

end of each month and compare it to the actual balance

for the same month. When this comparison is

completed, the finance officer should review it carefully

for significant differences between the forecast and

actual figures. If actual cash balances are higher than

forecast, you may wish to invest a large share of the

construction funds, bearing in mind the need to leave a

continuous margin for unexpected outlays. If balances

are lower than forecast, closer scrutiny is needed. The

finance officer must determine if the forecast was

incorrect or if the lower balances are an indication of

future cash-flow problems. If the balances are lower,

you may have to take one of the following corrective

steps:

• seek other revenue;

• reduce the scope of the project to meet available

revenue; or

• if total revenues are still expected to meet or exceed

total expenditures, but there is a timing problem,

either (1) borrow the difference needed to assure a

positive cash balance throughout the project, o.r (2)

restructure construction to delay some expendItures

until revenues are available. Costs of the delay,

however, are not allowable costs under the EPA

grant program.

While a project budget is generally permanent,

remaining the same throughout the life of the project,

the cash-flow forecast must be updated regularly

throughout the process.

* * * * * * * * * * * * * *

TIP: It is a good practice to develop an updated cashflow forecast every month, after reviewing the cash

balance report. This new forecast should reflect the

actual cash-flow up to the date ofthe forecast, with a

ievised monthly forecast ofall sources and uses for the

remainder ofthe project.

The approach recommended in the tip above allows you

to keep a continuous eye on the cash position, adjusting

both forecasts and operations to changing conditions.

Like the budget report, the cash-flow report should

include some interpretation by the chief finance officer

and should be circulated to the construction manager,

the chief administrative officer, and the legislative body.

CONCLUSION

Exhibit 12 reviews the steps entailed in managing

finances during the construction phase. Financial

management during the construction phase is basically a

matter of putting the systems developed earlier in the

process to work. It is also a matter of investing

construction funds wisely to secure the maximum

interest earnings without ever risking the funds. If you

invest carefully, manage your contracts, establish an.

adequate accounting system, account for all transactIOns,

maintain adequate cash balances and stay within your

budget, you will be virtually certain of sucessfully

completing construction. You will be standing on. third

base, with the bulk of the work completed, but sull

needing one more hit to score a run. If you fail to

manage your finances properly, the result could be

extremely costly, possibly causing a stoppage of work on

the project.
Exhibit 12

49 _II

Matrix of Functions Performed in

the Construction Phase

* * * * * * * *

What is Done Who Does it When To and With Whom

ESTABLISHING Finance Once Internal

ACCOUNTING Officer staff

SYSTEMS

RECORDING Finance Daily Internal

TRANSACTIONS Officer staff

INVESTING Finance At least With banks

CONSTRUCTION Officer or once a year and brokers

FUNDS Treasurer

MANAGING Purchasing Daily With the Prime

THE Agent, Construction Contractor and

CONTRACT Manager, Chief the Engineer

Executive

MONITORING Community At least To Chief

PROJECT Finance monthly Executive

PROGRESS Officer and Governing

Body

OVERALL Project Throughout the All team members

PROJECT Manager project involved in this

MANAGEMENT phase
I

CHAPTER V

The

• project

completion

phase:

• crossIng

the plate

Once construction is underway, you must make final

plans for the financial actions that will be necessary to

finance and operate the facility and to complete the

grants process. For EPA-funded construction projects,

there are three major actions to be completed once the

construction costs are known:

• implementing the user charge system and rates;

• selling the bond issue; and

• preparing for EPA's audit of the project.

If your community has followed the steps listed in the

three previous chapters, the tasks described in this

chapter will simply be the logical conclusion to processes

that are already well underway. In the pre-construction

process, for instance, you began development of a

revenue plan and an adequate user charge system. Now

you must adopt and implement the new rate structure.

You also determined the type of bond issue and are now

ready to sell the bonds. During construction, you

established and maintained project records and reports.

Now you should prepare them for the EPA grant audit.

IMPLEMENTING

THE REVENUE PLAN

AND USER CHARGE SYSTEM

Before beginning construction, you also completed

development of a revenue plan, including the system of

new user charges. (The study process is described in

Chapter III.) Since the purpose of user charges is to

provide enough revenue to operate and maintain the new

treatment facility, you must now take the actions

necessary to enact the rates before finishing the project.

If your community receives an EPA grant, Federal

regulations require that an approved user charge system

be enacted before the facility begins operating.

Your governing body should take the final action by

adopting an ordinance implementing the rates. This

process should involve public notification and citizen

participation in the rate-setting process. An ordinance

should specify the rates (distinguishing between user

charges and debt service charges), collection method,

penalties for late payment, and other administrative

features. Once the ordinance is adopted, all customers

should be given advance notice of the new rates. You

should also establish a system to review and update rates

annually, so that user charge revenue keeps up with

increases in costs. This review can best be done in the

process of developing and adopting the annual operating

budget for wastewater treatment.

51
I 52

* * * * * * * * * * * * * *

TIP: Long-term self-sufficiency ofthe treatment plant

can be ensured by writing the rate ordinance so that any

required rate increases are automatically built into the

operating budget approval process.

SELLING BONDS

Issuing bonds is a complex process that involves many

players and legal restrictions. This area may be new to

many small jurisdictions. It is important to allow enough

time to complete the process and to carefully plan and

manage each step in order to assure that long-term

financing is secured in a reasonable time frame.

**************

TIP: Since the time needed to complete a bond sale

varies with the type and complexity ofthe sale, the

length oftime needed should be determined well in

advance ofthe need to sell the bonds. You should time

the bond sale so that proceeds are available to payoff

any short-term financing and any costs ofconstruction

that will not be paid from cash or short-term financing.

The process for issuing bonds varies widely depending

on State laws and on the characteristics of the particular

bond issue. You must determine the type of long-term

financing (general obligation or revenue) very early in

the process before notes are sold to provide for interim

financing. As a rule of thumb, you should begin

preparing for the bond issue (as described below) no less

than three months before the desired closing date

(assuming that a bond election, if required, took place

prior to construction). You must work closely with bond

counsel and the financial advisor to set a realistic bond

sale schedule.

Issuing bonds consists of three major phases: design,

marketing, and closing. As indicated in Chapter III, the

selection and design of the permanent financing

arrangement must occur prior to the issuance of shortterm debt to fund construction. BANs are secured by

the ability of the community to sell its long-term debt.

All steps necessary to allow the community to issue its

long-term debt, whether it be general obligation or

revenue debt, must be completed before BANs are

issued. The decision on the form that the permanent

financing will take, therefore, is made very early in the

planning process. The actual marketing, sale, and closing

of the long-term financing are accomplished in the

project completion phase. These processes are described

below.

Marketing the Issue

Once the structure of the issue is decided, you must

begin the marketing process. The first task is to prepare

the following necessary bond sale documents:

• An official statement. It presents the terms by which

the bonds are to be offered, as well as financial and

economic information on the issuing agency and the

community as a whole. It is crucial that the financial

advisor coordinate the preparation and distribution

of the official statement to ensure its completeness

and accuracy.

• A notice of sale. Prepared by bond counsel, this

notice is published as required by State or local law.

It summarizes the structure of the issue and the

terms of the sale.

• An official bid form. Prepared by the financial

advisor and bond counsel, it is used to present the

bids. This form serves as the preliminary agreement

between the issuer and the underwriter who

purchases the bonds.

• An indenture (see the discussion of the design phase

in Chapter III). This will be prepared by bond

counsel and the financial advisor. As when shortterm financing is chosen, the issuer's finance officer

and attorney should carefully review the agreement

to ensure understanding of its relationship to future

system operation.

The second task is to obtain a bond rating on the

proposed issue. Bonds may be sold without a rating, but

investors sometimes expect higher interest rates in

exchange for the lack of an independent appraisal of the

creditworthiness of the issue. A small issue that will be

sold mainly to local investors, however, does not usually

need to be rated.

* * * * * * * * * * * * * *

TIP: The financial advisor should solicit input from

potential underwriters to determine the need for a rating

on small issues. Ifyou have outstanding debt that has

been rated, all subsequent issues with the same security

should also be rated. Failure to request a rating ofa new

issue with the same security provisions as currently

rated debt could result in the withdrawal ofthe existing

rating.

Bond issues can be rated for a fee by one of the major

rating agencies located in New York City. The rating is

then periodically reviewed until the bond is paid off. A

rating expresses the quality of a bond and its credit risk.

The four principal factors evaluated to rate a general

obligation bond are the issuer's current and planned

debt burden, financial strength, administrative abilities,

and the community's economic condition. For revenue
I

bonds, the revenue-producing potential of the project is

of primary importance. The financial advisor will

normally assist in securing a rating. It is extremely

important that all information requested by the rating

agency be submitted well before the sale. The rating will

normally be assigned and released to the investment

community several days before the sale.

If the issue is to be competitively sold, a third task in

marketing is to advertise the bonds for prospective

investors. Advertisements should be placed in

nationally recognized sources of information on the

municipal bond market, such as The Bond Buyer, and in

local newspapers. Official statements should be sent to

banks and underwriters identified by the financial

advisor and to any other potential purchasers who

express interest.

Closing the Sale

The issue is completed with the following steps:

• Award the bids. The award is made in conjunction

with bond counsel and financial advisor after all bids

have been received, verified, and tabulated. The

formal award is usually made by the governing body.

• Print the bonds. Bonds are usually printed by

financial printers. Timing the printing of the bonds

to be completed shortly after the sale of the bonds is

important because the paying agent and registrar

must have several days to prepare the bonds for

delivery at closing.

• Close the bond issue. At closing, the financial advisor

will verify final closing figures (the amount the

purchaser owes the municipality). Closing documents

prepared by bond counsel and the issuer are

provided as a formal record of the transaction to the

paying agent/registrar and the underwriter.

• Establish payment mechanisms. The paying

agent/registrar will formally adopt systems for

making interest and principal payments and for

transferring bonds between owners. The issuer

should also establish a schedule of payments to assist

in cash-flow planning throughout the life of the

bonds.

PREPARING FOR

THE GRANT AUDIT

All construction projects that are funded by EPA grants

may be subject to an audit by the Agency's Office of the

Inspector General before the grant is formally closed.

For additional information, refer to the EPA brochure

entitled, "What to Do Before and After the Auditors

Arrive." The purpose of the audit is to verify that all

expenditures to be reimbursed by the grant are properly

authorized, documented, and eligible for grant funding.

You and your contractor must maintain complete and

orderly records. When you are notified that an audit will

take place, staff should assemble the following records

that will be needed by the auditor:

• grant applications, agreements, amendments, and

contracts;

• accounting records that document receipt and

disbursement of funds, payroll expenses, travel,

payments to contractors, purchases of equipment and

supplies related to the project, and documentation of

in-kind (non-cash) payments;

• project bank account statements and cancelled

checks;

• copies of all reports required under the grant (e.g.,

progress reports, facility plans, user fees, and

industrial cost recovery reports);

• copies of financial status reports (budgets, budget

reports, cash-flow reports, etc.) and copies of outlay

reports and requests for reimbursement;

• copies of plans, specifications, change orders, and

"as-built" drawings;

• copies of public notices of property acquisition and

relocation actions; and

• Copies of audits conducted under OMB Circular A128. (EPA auditors will build on the work of the A128 audit to the extent possible.)

An audit will be a less difficult process if you have

developed a logical system for retaining records.

Auditors will work with your staff to discuss the

scope of the audit and will also discuss the findings

of the audit before a final report is issued. You will

be given an opportunity to respond to all audit

findings and exceptions.

CONCLUSION:

SAFE AT HOME

Exhibit 13 shows the efforts required of your

community to complete the project. The common

element in the three processes covered in this section is

the need to plan ahead for completing the project. The

community that "gets a jump" on this process is likely

to have its new charges adopted well in advance of their

implementation, complete the bond sale successfully,

and have no trouble with the audit. You will have

reached home plate because you looked ahead to the

next base, planned your route, and minimized the risk of

getting tagged out.

53- II
I 54

Exhibit 13

-II

Matrix ofFunctions Performed in

the Project Completion Phase

* * * * * * * *

What is Done Who Does it When To and With Whom

IMPLEMENTING Attorney Before facility Chief Administrator

USER is operational Legislative Body

CHARGES

SELLING Finance Before short-term Bond Counsel

BONDS Officer financing matures Financial Advisor

PREPARING Finance When all receipts Finance Staff

FOR Officer have been collected Purchasing Agent

AUDIT and all

disbursements have

been made

MANAGING Project Throughout All team members

THE Manager the project involved in this

PROJECT phase
I

CHAPTER VI

Conclusion:

the post-game

wrap-up

By following the handbook's approach to financial

management, you can score a run by successfully

completing your wastewater treatment facility. The feat

is made possible by an approach to the problem that

realizes the necessity of rounding the diamond just one

base at a time. You reach first base with a

comprehensive capital plan, a well-rounded team of

employees and consultants and a well thought out

project design. You proceed to second with sound

interim financing, a good construction contract, and

careful budgeting and cash-flow planning. Once on

second, you advance to third by building the facility,

backing up construction with conservative investment

practices, strong contract management, welldocumented accounting, and regular financial reporting.

The circuit is completed by setting user charges,

arranging permanent financing, and preparing records

for the grant audit.

The importance of this incremental, one-base-at-a-time

approach cannot be emphasized strongly enough. You

simply cannot expect to build a facility successfully

without laying out the groundwork in the previous

phases. Examples of the foolishness of any other

approach abound. You may put yourself in a real bind if

you cannot sell bonds because you failed to understand

the legal restrictions on bonding early in the process;

you cannot arrange correct interim financing without

understanding the total budget, the cash-flow patterns,

and arbitrage restrictions; you cannot use the

construction contract to force adequate performance if

you did not develop a sound contract in the first place.

All of these problems can and do happen in facility

construction projects where the community fails to

manage the project properly. You can be sure to avoid

them by carefully following the steps, in the right order,

as recommended in this handbook.

As noted in Chapter I, this handbook cannot cover every

detail of managing finances during construction.

Appendix A contains a glossary of terms that are

common in project financing, and Appendix B contains

a bibliography of additional reference materials. While

the handbook provides a good introduction and overview

of the process, you will need to refer frequently to the

EPA regulations as well as to more detailed materials in

order to ensure success. By using these sources, and by

carefully planning, controlling, and managing the

process, you will ensure that your community gets its

new treatment facility with no financial problems.

57

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Appendix A: Glossary Accounting System

The total set of records and procedures which are used to record,

classify, and report information on the financial status and operation

of an entity. (p. 6)

Accrual Basis of Accounting

The method of accounting under which revenues are recorded when

they are earned (whether or not cash is received at that time) and

expenses are recorded when goods and services are received or

incurred (whether cash disbursements are made at that time or not).

(See also "Modified Accrual Basis of Accounting" and "Cash Basis

of Accounting.") (p. 42)

Appropriation

An authorization made by the legislative body of a government

which permits officials to incur obligations against and to make

expenditures of governmental resources. Appropriations are usually

made for fixed amounts and are typically granted for a one-year

period. (p. 7)

Arbitrage

Borrowing money in the tax-exempt market (through issuing notes

or bonds) and then reinvesting that money at higher, taxable

interest rates. (p. 22)

Audit

A systematic examination of resource utilization concluding in a

written report. It is a test of management's internal accounting

controls and is intended to:

• ascertain whether financial statements fairly present the financial

position of the community and results of operations;

• test whether transactions have been legally performed;

• identify areas for possible improvements in accounting practices

and procedures;

• ascertain whether transactions have been recorded accurately

and consistently; and

• ascertain how faithfully officials performed their responsibilites.

(p.7)

Balance Sheet

A statement purporting to present the financial position of an entity

by disclosing the value of its assets, liabilities, and equities as of a

specified date. (p. 45)

Bond

A written promise to pay (debt) a specified sum of money (called

principal or face value) at a specified future date (called the

maturity date) along with periodic interest paid at a specified

percentage of the principal (interest rate). Bonds are typically used

for long-term debt. (p. 6)

Bond Anticipation Notes

Short-term interest bearing notes issued in anticipation of bonds to

be issued at a later date. The notes are retired from proceeds of the

bond issue to which they are related. (p. 22)

Bond Indentures

A legal document that spells out the obligations of a community in

connection with the issuance of debt. (p. 26)

59 - II
I 60

Glossary Budget (Capital)

A plan of proposed capital expenditures and the means of financing

them. The capital budget is usually enacted as part of the complete

annual budget which includes both operating and capital outlays.

The capital budget should be based on a capital improvement

program. (p. 7)

Budget (Operating)

Plans of current expenditures and the proposed means of financing

them. The annual operating budget (or, in the case of some State

governments, the biennial operating budget) is the primary means

by which most of the financing acquisition, spending, and service

delivery activities of a government are controlled. The use of annual

operating budgets is usually required by law. Even where not

required by law, however, annual operating budgets are essential to

sound financial management and should be adopted by every

government. (p. 10)

Capital Assets

Assets of significant '1_alt!~._~I!ghaying..a.-uoM"lf.uUi£e.{)f.se¥ual.y~~._

Capital assets are also called fixed assets. (p. 8)

Capital Improvement Program

A plan for capital expenditures to be incurred each year over a fixed

period of several future years setting forth each capital project,

identifying the expected beginning and ending date for each project,

the amount to be expended in each year, and the method of

financing those expenditures. (p. 6)

Capital Outlays

Expenditures which result in the acquisition of, or addition to, fixed

assets. (p. 34)

Capital Projects

Projects which purchase or construct capital assets. Typically, a

capital project encompasses a purchase of land and the construction

of a building or facility. (p. 5)

Cash Basis of Accounting

A basis of accounting under which transactions are recognized only

when cash changes hands. (See also "Accrual Basis of Accounting"

and "Modified Accrual Basis of Accounting.")

Cash-Flow Forecast

A projection of the cash receipts and disbursements anticipated

during a given time period. Typically, this projection covers a year

and is broken down into separate projections for each month, week,

and day during the year.

Certificate of Deposit

A negotiable or non-negotiable receipt for monies deposited in a

bank or other financial institution for a specified period at a

specified rate of interest. (p. 43)

Collateralization

The process of providing additional security for an investment by

setting aside other securities that will be available to the investor in

the event of a loss on the original investment. (p. 43)

-II
I

Glossary Cost Accounting

The method of accounting which provides for assembling and

recording all the elements of cQst ~d..tQ aCCPU1J2.lish a purpose,

to carryon an activity Or ~eration, orto complete a unit of work or

a specific job. ...

Debt

-An obligation resulting from the borrowing of money or from the

purchase of~pods and ~'1~ otgovernments rn-~ bg,w:ls, time warrants, and floating debt. (p. 6) -----_. -~

Debt Limit

The maximum amount of gross or net debt HI' , :is legally

permitted. (p. 7)

Debt Service

Payment of interest and repayment of principal to holders of a

government's debt insJruments. (p. 7,)

Debt Service Fund

A fund established to provide for the payment of principal and

interest on long-term deb~. Also called a sinking fund.

Debt Service Reserve

Funds set aside (usually from issue proceeds) to provide additional

security for a debt obligation. The amount is usually equal to either

average annual debt service or maximum annual debt service.

(p. 10)

Deficit

(1) The excess of the liabilities of a fund over its assets. (2) The

excess of expenditures over {evenues during an accounting period,

or in the case of proprietary funds, the excess of expense over

income during an accounting period.

Demand Deposit

A deposit of monies where the monies are payable by the bank upon

demand.

Depreciation

The decline in value of a fixed asset over time as a result of wear

and tear, deterioration, action of the physical elements, inadequacy,

and obsolescence. (p. 41)

Direct Net Debt

Gross direct debt less debt that is self-supporting (revenue bonds)

and double-barreled bonds (general obligation bonds secured by

earmarked revenues which flow outside the general fund).

Double-Barreled Bonds

General obligation bonds that are initially secured by a stream of

revenues or special assessments. '-

61 -II

-
I 62

Glossary Encumbrances

Obligations in the form of purchase orders, contracts, or salary

commitments which are chargeable to an appropriation and for

whicha part of the appropriation is reserved.

Enterprise Fund A fund established to account for operations (a) that are financed

anaQQ~9ted ina manner similar to private bl1.§i!!C;:{i.§.;~m~rpris~s,.~

where the intent of the governing body is that t1~..£Qll~,.(expenses,

including depreciation) of providing goods or services to the general

public ona continuing basis be financed or re<';9yue.cLprimarily

throughJ.!~e!,- charges,.Qr(b) where the governing body has decided

thatperilldicdelcrmination of revenues earned, expenses incurred,

and net income is appropriate for capinll maintenance, public

policy, management control, accountability, or other purposes.

Examples enterprise funqs are those for wi~tew_at~Ltre~l~nt

~ms, ;Yj!!fr:,.gasLel.~stri.c.\l.tiliJies, swimming pools,ai,ip.<?Ets,_

J2..alking...wI~ges, and transit systems. (p. 34) ....-.,-, "'''''.•,-, .. , -0.'-', .··-0·,_".....,'< ..... ,

Enterprise Fund Accounting

Accounting used for government operations that are financed and

operated ina manner similar tb business enterprises, and for which

preparation of an income statement is desirable. Unlike

governmental-type funds which are accounted for on the modified

accrual basis, enterprise-type funds are accounted for on an accrual

basis.

Expenditures

Decreases in net financial resources. Expenditures include current

operating expenses which require the current or future use of net

current assets, debt service, and capital outlays. (p. 6)

Expenses

Decreases in net total assets. Expenses represent the total cost of

operations duringa period regardless of the timing of related

expenditures. (p. 22)

Fixed Assets

Assets ofa long-term character which are intended to continue to be

held or used, such as land, buildings, improvements other than

buildings, machinery, and equipment.

Floating Debt

Obligations that are payable either on demand or with very short

maturities, such as accounts payable, bank loans, or warrants.

Full Faith and Credit A pledge of the general taxing power for the payment of debt

obligations. Bonds carrying such pledges are referred to as general

obligation bonds or full faith and credit bonds. (p. 42).

Fund A fiscal and accounting entity with

a self-balancing set of accounts

recording cash and other financial resources, together with all

related liabilities and residual equities or balances, and changes

therein, which are segregated for the purpose of carrying on specific

activities or attaining certain objectives in accordance with special

regulations, restrictions, or limitations.

.11
I

Glossary Fund Balance

The excess of an entity's assets over its liabilities.A negative fund

balance is called

a deficit. (p. 31)

General Fund

The fund used to account for all financial resources except those

required to be accounted for in another fund.

General Obligation Bonds

Whena government pledges its full faith and credit to the

repayment of the bonds it issues, then those bonds are general

obligation (GO) bonds. Sometimes the term is also used to refer to

bonds which are to be repaid from taxes and other general revenues.

(p.7).

Generally Accepted Accounting Principles (GAAP)

Uniform minimum standards of and guidelines to financial

accounting and reporting. They govern the form and content of the

basic financial statements of an entity.

GAAP encompass the

conventions, rules, and procedures necessary to define accepted

accounting practice ata particular time. They include not only

broad guidelines of general application, but also detailed practices

and procedures. GAAP providea standard by which to measure

financial presentations. The primary authoritative statement on the

application of GAAP to State and local governments is the National

Council on Governmental Accounting's Statement 1. Every

government should prepare and publish financial statements in

conformity with GAAP. The objectives of governmental GAAP

financial reports are different from, and much broader than, the

objectives of business enterprise GAAP financial reports.

Generally Accepted Auditing Standards (GAAS)

Measures of the quality of the performance of auditing procedures

and the objectives to be attained through their use. They are

concerned with the auditor's professional qualities and with the

judgment exercised in the performance of an audit. Generally

accepted auditing standards have been prescribed by (1) the

American Insititute of Certified Public Accountants (AICPA) and

(2) the U.S. General Accounting Office (GAO) in Standards for

Audit of Governmental Organizations, Programs, Activities,

&

Functions (the "yellow" book).

Gross Direct Debt

The total amount of bonded debt ofa government (general

obligation bonds plus revenue bonds).

Industrial Development Bonds

State and local government bonds issued to finance private projects

that are usually only backed by revenues from the facility being

financed (industrial revenue bond). They are almost always taxexempt, but only because they satisfy numerous legal requirements

regarding the size of issue, use of proceeds, and degree of privatesector involvement. For an explanation of exemptions and

restrictions see Section I03(b) of the Internal Revenue Code. (Also

called industrial revenue bonds.)

63
I 64

Glossary Internal Control

A plan of organization under which employees' duties are so

arranged and records and procedures so designed as to make it

possible to exercise effective accounting control over assets,

liabilities, revenues, and expenditures. Under such a system, the

work of employees is subdivided so that no single employee

performs a complete cycle of operations. Thus, for example, an

employee handling cash would not post the accounts receivable

records. Moreover, under such a system, the procedures to be

followed are definitely laid down and require proper authorizations

by designated officials for all actions to be taken. (p. 39)

Investment

Securities purchased and held for the production of income in the

form of interest or dividends. (p. 7)

Key Debt Ratios

Figures compiled from a broad cross-section of debt issuers that

provide a basis of comparison to determine municipal

creditworthiness. (p. 9)

Levy

(Verb) To impose taxes, special assessments, or service charges for

the support of governmental activities. (Noun) The total amount of

taxes, special assessments, or service charges imposed by a

governmental unit.

Liability

Debt or other legal obligation arising out of transactions in the past

which must be liquidated, renewed, or refunded at some future

date. This term does not include encumbrances.

Limited Liability Bonds

When a government issues bonds which do not pledge full faith and

credit of the jurisdiction, it issues limited liability bonds. Typically,

pledges are made to dedicate one specific revenue source to repay

these bonds, or some other special repayment arrangements are

made.

Line Item Budget

A budget prepared along departmental lines that focuses on what is

to be bought.

Liquidity (of Investments)

The ability to convert an investment to cash promptly with

minimum risk to principal or accrued interest. (p. 43)

Maturities

The dates on which the principal or stated values of investments or

debt obligations mature and may be reclaimed. (p. 22)
Glossary Modified Accrual Basis of Accounting

The accrual basis of accounting adapted to the governmental fund

type. Revenues are recognized when they become both

"measurable" and "available to finance expenditures of the current

period." Expenditures are recognized when the related fund liability

is incurred except for: (1) inventories of materials and supplies

which may be considered expenditures either when purchased or

when used; (2) prepaid insurance and similar items which need not

be reported; (3) accumulated unpaid vacation, sick pay, and other

employee benefit amounts which need not be recognized in the

current period, but for which larger-than-normal accumulations

must be disclosed in the notes to the financial statements; (4)

interest on special assessment indebtedness which may be recorded

when due rather than accrued, if approximately offset by interest

earnings on special assessment levies; and (5) principal and interest

on long-term debt which are generally recognized when due. All

governmental funds and expendable trust funds are accounted for

using the modified accrual basis of accounting.

Net Income

The excess of operating revenues, nonoperating revenues, and

operating transfers-in over operating expenses, nonoperating

expenses, and operating transfers-out.

Net Interest Cost (NIC)

The average interest rate ona bond issue, used as an equivalent of

simple interest and the amount of the issue. (p. 24)

Objects of Expenditure

Expenditure classifications based upon the types or categories of

goods and services purchased. Typical objects of expenditure

include: • personal services (salaries and wages); • contracted services (utilities, maintenance contracts, travel); • supplies and materials; and • capital outlays.

Official Statement A legal document which summarizes all the salient features of the

underlying documents and agreements which supporta municipal

bond offering. It is considered the disclosure document which

presents information that is "material" to the offering. The official

statement should contain everythinga reasonable investor would

need to know in makinga decision about the issue. Thus this

document will usually includea description of the issuer,

a

description of the security of the bond,

a summary of the principal

financing documents, any feasibility studies which relate to the

security, and any other "key information." (p. 16)

Operating Budget

Plans for current expenditures and the proposed means of financing

them. The annual operating budget (or, in the case of some State

governments, the biennial operating budget) is the primary means

by which most of the financing acquisition, spending, and service

delivery activities of

a government are controlled. The use of annual

operating budgets is usually required by law. Even where not

required by law, however, annual operating budgets are essential to

sound financial management and should be adopted by every

government. (p. 10)

65 -II
I 66

Glossary Operating Expenses

Proprietary fund expenses which are directly related to the fund's

primary service activities. (p. 34)

Operating Income

The excess of proprietary fund operating revenues over operating

expenses. (p. 26)

Operating Revenues

Proprietary fund revenues which are directly related to the fund's

primary service activities. They consist primarily of user charges for

services.

Operation, Maintenance and Replacement

Activities required to assure the dependable and economical

function of treatment works. (1) Maintenance: Preservation of

functional integrity and efficiency of equipment and structures.

This includes preventive maintenance, corrective maintenance, and

replacement of equipment. (2) Operation: Control of the unit

processes and equipment which make up the treatment works. This

includes financial and personnel management records, laboratory

control, process control, safety, and emergency operation planning.

(p. 16)

Opportunity Cost

The return in benefit that would have been received if an alternative

course of action had been pursued.

Overall Net Debt

The sum of direct net debt and overlapping debt.

Overlapping Debt

The proportionate share of the debt of local governments located

wholly or in part within the limits of the reporting government

which must be borne by property within the reporting government.

Purchase Order

A document which authorizes the delivery of specified merchandise

or the rendering of certain services and the making of a charge for

them.

Quarterly Expenditure Plan

The annual budget for a governmental activity can be subdivided

into four three-month budgets, called quarterly expenditure plans.

They can be used to monitor actual expenditures more closely and

to identify problems more quickly than can be done with the annual

budget.

Replacement

Obtaining and installing equipment or accessories which are

necessary during the useful life of the treatment works to maintain

the capacity and performance for which such works were designed

and constructed. (p. 8)

Replacement Cost

The cost as of a certain date of a property which can render similar

service (but which need not be of the same structural form) as the

property to be replaced. (p. 8)

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I

Glossary Requisition

A written demand or request, usually from one department to the

purchasing officer or to another department, for specified articles or

services.

Reserve

An account used to indicate that a portion of fund equity is legally

restricted for a specific purpose or not available for appropriation

and subsequent spending. (p. 8)

Revenue

The term designates an increase to a fund's assets from sources

other than refunds, capital contributions, residual equity transfers,

loan proceeds, or transfers-in. (p. 8)

Revenue Bonds

Bonds whose principal and interest are payable exclusively from

earnings of an enterprise fund. In addition to a pledge of revenues,

such bonds sometimes contain a mortgage on the enterprise fund's

property. (p. 8)

Revenue Debt Capacity

The amount of revenue debt that can be secured by the stream of

revenue pledged to redeem that debt. (p. 10)

Revenue Estimate

A formal estimate of how much revenue will be earned from a

specific revenue source for some future period; typically, a future

fiscal year.

"Rolling" the Notes

The reissuance of short-term debt at maturity to provide additional

time to either complete construction of the facility being financed or

to redeem the debt.

Serial Bonds

Bonds whose principal is repaid in periodic installments over the

life of the issue. (p. 26)

Sewer Service Charge

The total system charge for wastewater treatment services,

including user charges and debt service charges.

Sinking Fund

A fund established to account for the accumulation of resources for,

and the payment of, the principal and interest of general long-term

debt. (p. 26)

Special Assessment

A compulsory levy made against certain properties to defray part or

all of the cost of a specific improvement or service deemed to

primarily benefit those properties.

Special Assessment Bonds

Bonds payable from the proceeds of special assessments. If the

bonds are payable only from the collections of special assessments,

they are known as special assessment bonds. If, in addition to the

assessments, the full faith and credit of the government are pledged,

they are known as general obligation special assessment bonds or

double-barreled bonds.

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Glossary Special Assessment District

A legally established area for the express purpose of levying a

special fee for public improvements that are of a special rather than

general benefit. (p. 9)

Special Assessment Fund

A fund used to account for the financing of public improvements or

services deemed to benefit primarily the properties against which

special assessments are levied.

Special District Bonds

Bonds issued by a special district.

Tax Rate Limit

The maximum legal rate at which a municipality may levy a tax.

The limit may apply to taxes raised for a particular purpose or for

general purposes.

Term Bonds

Bonds which mature in a single, large block on some future date

(usually 10-20 years). Redemption is usually made from funds

deposited into a sinking fund each year. (p. 26)

Transfer

The movement of monies from one fund to another. (p. 8)

Unit Cost

A term used in cost accounting to denote the cost of producing a

unit of product or rendering a unit of service; for example, the cost

of treating 1,000 gallons of sewage.

User Charge or User Charge System

A charge or system of charges levied on users of a treatment works

for the user's proportionate share of the cost of operation and

maintenance (including replacement) of such works under sections

204(b)(l)(A) and 201(h)(2) of the Clean Water Act. (p. 6)

Variable Cost

A cost that increases or decreases with increases or decreases in the

amount of service provided, such as the payment of a salary.

Voucher

A written document which is evidence of the propriety of a

particular transaction and typically indicates the amounts to be

affected by the transaction.

Warrant

(I) A certificate enabling the bearer to purchase additional bonds of

a particular entity within a limited time period at a pre-specified

coupon rate. (2) A short-term security that represents a liability of

the issuer to be paid on a certain date, often placed directly with a

vendor or a bank.

Yield

The rate earned on an investment based on the price paid for the

investment, the interest earned during the period held, and the

selling price or redemption value of the investment. (p. 43)

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I

Appendix B: Bibliography

Environmental Protection Agency. Accounting Guide for

Construction Grants. Washington, DC: EPA, 1977 (29pp).

Environmental Protection Agency. Construction Grants 1985.

Washington, DC: EPA, 1984 (300pp).

Environmental Protection Agency. Construction Grants Program

for Municipal Wastewater Treatment Works: Handbook of

Procedures. Washington, DC: EPA, October 1, 1984 (962pp).

Environmental Protection Agency. Financial Capability Guidebook.

Washington, DC: EPA, 1984 (68pp).

Environmental Protection Agency. Management ofa Construction

Project: A Guide for Grantees. Washington, DC: EPA, 1986.

Environmental Protection Agency. Management ofConstruction

Change Orders: A Guide for Grantees. Washington, DC: EPA,

March 1983.

Environmental Protection Agency. Office ofInspector General

Report to Congress. Washington, DC: EPA, 1985 (lOpp).

Environmental Protection Agency. Prevention and Resolution of

Contractor Claims: EPA Construction Grant Program Guidance for

Municipal Grants. Washington, DC: EPA, March 1985 (llpp).

Environmental Protection Agency. User Charge Guidance Manual

for Publicly-Owned Treatment Works. Washington, DC: EPA,

1984 (25pp).

Graves, Ralph E. Manual ofProcurement Codes and Practices for

Local Government. Washington, DC: Urban Management

Curriculum and Development Project (lOOpp).

Korbitz, William E. Urban Public Works Administration.

Washington, DC: International City Management Association, 1976

(563 pp).

Matzer, John Jr. Capital Financing Strategies for Local

Governments. Washington, DC: International City Management

Association, 1983 (208pp).

Miller, Girard. Capital Budgeting: Blueprints for Change. Chicago,

IL: Government Finance Officers Association, 1984 (313pp).

Moak, Lennox L. and Hillhouse, Albert M. Concepts and Practices

in Local Governmental Finance. Chicago, IL: Municipal Finance

Officers Association, 1975 (454pp).

Moak, Lennox L. Municipal Bonds: Planning, Sale and

Administration. Chicago, IL: Municipal Finance Officers

Association, 1982 (405pp).

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Bibliography

Moak, Lennox L. and Killian, Kathryn W. Operating Budget

Manual. Chicago, IL: Municipal Finance Officers Association, 1983

(347pp).

Moody's Investors Service. Pitfalls In Issuing Municipal Securities.

New York, NY: MIS, 1963 (83pp).

National Institute of Governmental Purchasing. Basic Public

Purchasing and Materials Management. Arlington, VA: National

Institute of Government Purchasing, 1977 (193pp).

Petersen, John E. and Hough, Wesley C. Creative Capital

Financing for State and Local Government. Chicago, IL:

Municipal Finance Officers Association, 1983 (256pp).

Public Securities Association. Fundamentals ofMunicipal Bonds.

New York, NY: PSA, 1981 (208pp).

Rosenberg, Philip. A Treatment Management Handbook for Small

Cities and Other Governmental Units. Chicago, IL: Municipal

Finance Officers Association, 1978 (98pp).

Rosenberg, Philip. A Treatment Management Handbook for Small

Cities and Other Governmental Units. Second Printing. Chicago,

IL: Municipal Finance Officers Association, 1979 (76pp).

Standard and Poor's. Credit Overview: Municipal Ratings. New

York, NY: Standard and Poor's, 1983 (104pp).

West Virginia Water Development Authority. Financial Tracking

Manual Dunbar, WV: WDA, 1985 (70pp).

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