The revenue requirement is the first number in a rate study and the one every other number in it depends on. It is what the utility has to collect from its customers over a year, and it is built from the bottom up.
What goes into it
- Operating and maintenance cost. Treatment chemicals and power, source of supply or purchased water, distribution and collection, meter reading and billing, customer service, and the administrative share the utility carries.
- Debt service. Principal and interest falling due in the year on outstanding revenue bonds, general obligation debt supported by the utility, and state revolving fund loans.
- Capital funded from rates. The share of the adopted capital improvement plan not funded by debt, grants or existing reserves.
- Coverage and reserves. The margin a rate covenant requires above debt service, plus any operating or capital reserve target the utility has adopted.
Non-rate revenue is then subtracted: interest earnings, connection and inspection fees, penalties, and rent from leased sites. What is left is what the rates have to raise.
Two ways to build it
The cash-needs approach adds the actual cash obligations of the year, which is how most municipal utilities budget and how most bond covenants are written. The utility-basis approach uses depreciation plus a return on rate base instead of debt service and rate-funded capital, and is the method a regulated investor-owned utility uses. A municipal system selling wholesale service to another system is often required to price that service on the utility basis while pricing its own retail service on the cash basis.
The two produce different totals from the same records. A study that does not say which one it used has not said what it calculated.
Sources
American Water Works Association, Principles of Water Rates, Fees, and Charges, Manual of Water Supply Practices M1, 7th ed. (2017), chapters on revenue requirements and the cash-needs and utility-basis approaches.