Water utility rate consultants are in the business of helping their clients figure out how much the rates need to be adjusted.  Once that first determination is made, the consultant is able to address other issues, like how to allocate costs to customers and develop equitable rates, but the first step is to know where you’re going.   In order to know where you’re going, you need to know where you would end up anyway without any changes to your rates and compare that revenue point to the expected costs of service at that same point in time.  If you expect revenue of $100 against total costs of service of $110, for example, you need a 10% increase in your rates to balance your budget.

An overlooked part of a consultant’s work is the value of projecting revenues at current rates.   There are two major approaches for doing so: the top-down approach, and the bottom-up approach.  Each may be useful to you for different reasons.  To estimate revenue, one needs to know: (a) the Quantity (Q) of water sales, and (b) the Price (P) charged for those sales.  Both the bottom-up and top-down approaches contain estimates of P and Q, the difference is in how.

The bottom-up approach literally results in a revenue estimate from looking at many individual transactions.  A detailed bottom-up approach might examine each individual billing record for the previous few years and forecast revenue based on individual demands (Q) at the current rates (P); the revenue estimate would be equal to the summation of all expected account transactions for the following year.  Depending on the size of your system, a bottom-up approach like this could be cumbersome and time consuming.  However, one of the advantages of a bottom-up approach is that it gives you visibility over details that you may want to know.  Things like the amount of revenue from monthly service charges vs. volume-based charges; or things like the percentage of revenues earned for different levels of usage – very useful if you have inclining block water rates – are both things that you can quantify with a bottom-up approach.  One of the major drawbacks to a bottom-up approach though is that the more details you include, the more forecasting (i.e. guessing) is required.  Forecasting growth in customer accounts and related demands for individual accounts, or groups of accounts, can and usually does lead to small errors for each calculation – when you multiply that small error by the total number of your detailed estimates then you can easily end up with a wild estimate for total revenue.

The top-down approach is somewhat more simplistic. Instead of focusing on individual transactions or groups of transactions, a top-down approach will look at total Q delivered to all customers for a full year (although one could make monthly estimates just as easily) and apply an average price (P) per unit to the total Q to reach a revenue estimate.  In this case the average P is something that would have to be determined; we often look at total audited user charge revenues received divided by total Q delivered for the prior 2-3 periods and then adjust the average price as necessary for any known changes.  One of the advantages of the top-down approach is that Q can be forecast based on bigger picture planning numbers like total population growth projections from census information of state demography reports, or a master plan.  If Q was 100 in the prior year and expected population increase is 2% for next year, then expected quantity might be 102 (sometimes adjustments are proper to take into account large-scale changes, like additions of major commercial customers).   Other advantages of the top-down approach is that it requires fewer forecasts (i.e. guesses) and takes less time.  The downside is that you won’t have much by way of detail when you’re done and  you won’t be able to many detailed questions as a result.

Neither the top-down or bottom-up approach can be said to be more accurate than the other.  In general though, the choice of approach has more to do with the need for the information.  For financial planning or other calculations of revenue requirements, a top-down approach tends to work well because it allows for simple inputs and outputs that are more easily communicated to others.  When using a top-down approach you can say things like:  “I have 4% growth and a 3% increase in price, resulting in Revenue X.”  For other applications though, a bottom-up approach may be best if not required.  Most rate design and cost-of-service processes beg for more detail rather than less, and a bottom-up approach may be the only answer.