Value-based management : public water utilities, a financial consideration

Abstract

Water is the source of life on earth and sustaining a constant supply of safe drinking water is the responsibility of every human being. Although people can all do their part for water conservation by minimising and mitigating pollution, the supply of clean drinking water in South Africa is made possible by the Water Boards. Water Boards are public enterprises and are therefore non-profit organisations that function as normal business enterprises. Although some grants are issued under the Division of Revenue Act (Act 2 of 2006), for the most part the Water Boards are expected to be financially sustainable through generating sufficient revenue to cover all its costs. The Water Boards that fail to do so become dependent on government funding and in some instances have to borrow to finance its operations. Water Boards are therefore expected to manage its operations and finances optimally to become more independent and rely less on debt to cover its expenses. This means that less government support will be needed to ensure that the Water Boards remains viable. The funds directed towards the Water Boards can thus be used for more social value adding activities instead of being used to ensure the survival of the Water Boards. To become financially sustainable both the operations as well as the finances must be managed effectively. In this study only the financial management of the Water Boards are considered. The question is thus whether or not South African Water Boards manage its finances effectively to ensure financial sustainability so as to add value to its services delivered and to increase the living standard of the communities in which it operates. Financial performance measurement tools are used to measure the financial management of any company. There are numerous performance measurement tools to choose from and the choice lies with the company depending on the objectives of the company and what it is that needs to be measured. Although financial performance measurement tools are generally used by private entities, public entities are also able to use it since effective financial management is common to both.

The financial performance measurement tools fall into two categories, namely traditional and modern performance measures. The traditional performance measures are the ratios that have been used over the last few decades and the modern performance measures are value-based management (VBM) tools that are more recently developed. VBM takes the cost of debt and equity into consideration in calculating the value created through operations. Where the traditional performance measures are based on historical data, VBM can be used to calculate the future value of a company. The tools under the VBM framework that are discussed in this research are Shareholder Value Added (SVA), Cash-Flow Return on Investment (CFROI) and Economic Value Added (EVA). EVA and traditional financial analysis are used in this research to analyse the performance of the Water Boards and therefore a more in-depth literature study is conducted on EVA so as to clarify how it was calculated for the Water Boards. To answer the research question, both the EVA and the ratios were calculated for 15 of the South African Water Boards over a 5 year period from 2004 to 2008. This was done by making use of the Income Statements and Balance Sheets of the Water Boards. The ratios used under the traditional performance measurement framework are: operating profit margin, net profit margin, total asset turn-over ratio, current ratio, debt to assets ratio, equity multiplier, return on assets, return on equity and EVA. The results of all the performance measures were plotted on bar graphs to observe trend and establish connections between the variables. An industry average calculated from all. the publicly traded industrials on the Johannesburg Securities Exchange was used to benchmark the Water Boards with respect to the financial performance measurement tools. Finally, correlation matrices were used on all the performance measures of the Water Boards to determine whether or not there were relationships between the performance measures. From the empirical study it appears that the Water Boards tend to possess assets that are not optimally utilised. The higher prices of assets inevitably lead to a higher cost in acquiring the assets, which in turn decreases the EVA. All assets must therefore be fully utilised so that more revenue is generated in using the assets than the cost of acquisition of these assets. Both the EVA and the chosen traditional performance measures are used to determine whether the assets of the Water Boards are fully utilised and the finances are effectively managed.