Cash: “How much is enough?”

Baker Tilly’s clients often ask about the amount of cash that should be available in their enterprise funds.  Enterprise funds need sufficient cash to pay current expenses, together with principal and interest on outstanding bonds.  This would typically require an enterprise fund to have a minimum of three months of anticipated operating expenses and one year’s total debt service in cash at the end of each fiscal year.  However, this does not provide any level of cash reserves that may be required under the terms of a revenue bond resolution, or to provide for unforeseen expenses and emergencies, or to cover any shortfalls in the budget.  The amount of cash reserves that an enterprise fund should have depends on a number of factors, some of which are contingent on geographical location.  Some typical factors include:

• Reserves that are legally required
• Variability of the annual revenue stream
• Variability in annual expenses
• Age and condition of fixed assets
• Anticipated future capital needs
  
• Asset replacement and renewal reserve
• Tolerance for risk
• Number of relatively large customers
• Capital improvement plan
• Regulatory compliance

Cash flow is a measure of how much revenues exceed expenditures on a cash basis over the course of a fiscal year.  For those enterprise funds with outstanding revenue debt, there is typically a required prescribed level of debt service coverage each fiscal year.  Debt service coverage is a measure of the ratio of net revenues to annual debt service.  Typically, net revenues are determined for each fiscal year as follows:

Operating revenues

+  Interest income

+  Other revenues

=  Total available revenues

–  Operating expenses (excluding depreciation expense)

=  Net Revenues

Debt service coverage is then determined as shown below:

Net Revenues / Debt Service (Principal & Interest)

= Debt Service Coverage       

It is important to note that this debt coverage requirement is an annual operating revenue requirement and is completely independent of how much cash the enterprise fund has available.  Cash levels are irrelevant to this requirement.

In addition to the debt service coverage requirements, revenue bonds also typically require the issuer to maintain a debt service reserve.  The amount of this reserve is most often the lesser of either the max annual debt service for the bond, 125% of the average annual debt service, or 10% of the principal amount of the bond.

Baker Tilly’s Operational Finance Consultants can help you develop financial plans for your enterprise funds that will provide adequate cash reserve levels, meet debt service coverage ratios, and maintain required debt service reserves.

For more information on this topic, or to learn how Baker Tilly municipal specialists can help, contact our team.

Baker Tilly Municipal Advisors, LLC is a registered municipal advisor and wholly-owned subsidiary of Baker Tilly US, LLP, an accounting firm. Baker Tilly US, LLP, trading as Baker Tilly, is a member of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities.