Debt service coverage is net revenue for the year divided by the principal and interest due on the utility’s debt in that year. A ratio of 1.20 means the utility produced twenty percent more than it needed to pay its debt.
What counts as net revenue
Gross revenue less operating and maintenance expense. Which items fall on which side is set by the bond documents rather than by accounting convention, and the differences are material:
- Depreciation is excluded from operating expense, because it is not a cash cost and the covenant is a cash test.
- Debt service itself is excluded from operating expense, or the ratio would be computed against a figure that already deducted it.
- Transfers to the general fund may or may not be an operating expense, depending on the ordinance. If they are excluded, coverage looks stronger than the cash position is.
- Connection and impact fee revenue is often excluded from gross revenue, because it is non-recurring and a covenant met with it is a covenant met once.
Why a forecast needs it year by year
Coverage is not a property of a rate; it is a property of a year. A rate that covers 1.35 in the first year of a capital program can fall below the covenant three years later as new debt is drawn, without anything about the rate changing. The useful output is the first year the margin goes negative, and the increase that keeps it positive.
Sources
Municipal Securities Rulemaking Board glossary of municipal securities terms. American Water Works Association, Manual M1, 7th ed. (2017), on coverage as a component of the revenue requirement. The definitions that govern a specific utility are in its own bond ordinance.