Kipp Drummond has worked in finance in both the private and public sectors, including 6 years as the senior financial manager and comptroller for the Kennewick Irrigation District. In this interview, he brings his years of experience to bear to walk us through all the steps irrigation districts should go through to develop budgets and identify the best ways to raise capital.
Irrigation Leader: Please tell us about your background and your experience in the different organizations you’ve worked for.
Kipp Drummond: I have experience in both the private and public sectors. I have kept green bar manual general ledgers and implemented new enterprise resource planning systems. I have worked for a construction company and software startups; for a city and a county government; and for the Kennewick Irrigation District. I’ve seen capital creation from stock issuance to $40 million bond offerings.
Irrigation Leader: Would you discuss the budget of an irrigation district and how it might differ from those of other organizations?
Kipp Drummond: Irrigation districts, generally speaking, have a set number of customers and fixed revenue streams. Their revenues are capped, subject to rate increases. They have massive infrastructure and the associated high maintenance and capital costs. The resources devoted to infrastructure maintenance each year, as opposed to operations and capital expansion, is a critical budget and strategic decision to be made by senior management and the board. Each budget will reflect the board’s decision on how much to allocate to annual maintenance and the replacement of existing infrastructure. Other factors to keep in mind are that operational staff are often unionized, and that many irrigation districts are governmental and therefore require extreme transparency and accountability.
Irrigation Leader: How should an irrigation district organize and plan for budgeting?
Kipp Drummond: The options include annual or biannual budgets. Personally, I prefer annual budgets that include multiyear projections of both revenue and expense beyond the budget year. And, of course, capital plans are typically budgeted for 5–7 years.
On the broadest level, the organization’s long-term strategic goals and plan should inform and direct the budget process. A capital plan with the projected current year budget should be in place before the budget process starts.
The finance department, with direction from the executive director and input for the board, should also put together revenue projections with ranges and appropriate contingencies before budget process begins. The executive director should issue goals and rules for the budget process to lay out how the budget will permit the organization to meet the annual and long-term goals set by the board of directors. These goals and rules should cover process issues, required cuts, projects to be added or deleted, staffing changes, and so on. Area and division managers will have responsibility for their area budgets under the direction of the executive director. All employees who make purchasing or resource allocation decisions should be involved in the budget process. The public and customers should also be involved at the beginning and at the end of the process. Input from customers at the beginning may help shape the budget.
Do the budget in layers, starting with absolutely critical items, then those that are very desirable but not required, those that are important, and those that it would be nice to do. Allocate funds to meet critical needs first, then very desirable items, and so on. If cuts need to be made, this provides a framework for what to cut.
Irrigation Leader: Would you walk us through how to put together a budget?
Kipp Drummond: First, the organization’s short- and long-term goals should be clearly defined and assigned to operational groups. Next, revenue projections should be completed in several layers, with contingencies built in. A capital plan should be in place, covering the current year in detail. So should projected payroll and benefit expenses for the budget year for projected staffing levels with contingencies.
The executive director should issue goals, parameters, and processes for the budget process. Senior managers will submit draft budgets for their departments, consistent with the above, after consulting with all staff in their departments who make purchasing and resource allocation decisions. The executive director will assemble the budget based on these senior manager submissions and on meetings with senior managers. The budget should have contingency layers built in, including multiple future-year projections to show the future effects of current-year budget decisions.
Next, the board finance committee will meet with the executive director and senior managers. There ought to be an opportunity for customer and community comment on the draft budget, after which the board finance committee will meet with the executive director and senior managers again. Finally, the budget will go to the board for approval at a public meeting.
Irrigation Leader: Is the basic approach for addressing inflation to build slack into the budget, or is it acknowledging that certain discretionary spending items may be cut along the way?
Kipp Drummond: You can build your best estimates of inflation into individual budget line items; you can have inflationary contingencies for each line item or budget area; you can have an overall budget inflation contingency; or you can select items or areas that would be cut because of increased inflationary costs. Obviously, inflation will affect individual budget items differently. Using contingencies rather than just increasing line items will make it easier to track the effect of inflation. Tracking the effect of inflation will be important for senior managers, the board, and customers on an annual and multiyear basis. In extreme cases, you may want conduct budget reviews more frequently than the traditional monthly review. For governmental agencies, the question of how much of the cost of inflation can be passed on to the end user must be decided through a complicated board-level, executive-level discussion with input from customers and the community.
Irrigation Leader: Would you explain what zero-based budgeting is and what the advantages of that approach are?
Kipp Drummond: Zero-based budgeting is a way of ensuring that every projected budget expense is reviewed to confirm that it is both required and being delivered in the most economical way possible. The budget is built from scratch rather than on the prior year’s budget assumptions and numbers. Every expense is examined to see whether it is necessary and is being done as efficiently as possible. It is a way for managers to reexamine their assumptions; review processes and procedures; and possibly look for new, better ways to do things. Line and operational staff can be helpful in this review. It is a time to look at the deployment of staff and resources and to consider whether there might be new and better ways to meet the organization’s goals.
Irrigation Leader: How should an irrigation district choose the best way to raise capital, for instance for a building or rehabilitation project?
Kipp Drummond: You need to look at the project and ask what its short- and long-term fiscal effects are. (Obviously, the nonfiscal effects of a project can be important, too—increased safety, critical service delivery, and so on.) How much would it cost to do the project now versus in 3–5 years? How does the organization’s current cost of capital compare to what it is projected to be in 3–5 years? Would doing the project make the organization more efficient, thereby saving money in the future? Would it potentially decrease or increase costs in the future? Would it create revenue that could be used to repay project or capital costs?
Then, you need to look at any existing or potential revenue streams within the organization. Are resources being used optimally? Do current resource allocations reflect the organization’s current goals and objectives? Should resources be reallocated or redeployed for the project under consideration?
This environment is making things a lot more complicated. If you’ve got a project that will run for 3 years, what will the cost of diesel be then? It’s impossible to know, but you will need to come up with assumptions and estimates. If you think inflation is going to continue to be high, then delaying the project for a year or two may add significant additional expense. All this involves attempting to make predictions about global markets and inflation, which are enormously difficult to understand. You need
to find a few people whom you can consult. Ultimately, the executive director, the board, and senior managers need to be part of this process. They will need to be comfortable saying, “We don’t know what’s going to happen, but this is our best guess, and we will take this risk.”
Depending on how you raise money, there will be requirements for how quickly you spend it. Typically,
you need to spend bond proceeds within 3 years. You might decide to take a loan with a slightly higher interest rate to avoid that. In some cases—for example, if regulatory permits prevent you from breaking ground for several years—you might even choose to raise money now and sit on it for several years if you think it’s cheaper now than it will be then. Again, trying to predict future interest rates is complicated. You need to find good advisors and get the board and senior management involved. Even if you’re not planning to look at capital in the next year or two, somebody in the organization needs to be following interest rates so that there’s a historical understanding when you get to the point where you might need it. Talking to peer organizations, including sewer districts, water districts, and cities, is also important.
Irrigation Leader: Are there any other reasons why a district might prefer a loan to a bond?
Kipp Drummond: Generally, loans can be closed more quickly and with less formal legal work, paperwork, and expense. Local and regional banks are potential sources for loans. Bonds are issued by regional and national investment banks. Bonds require more legal work and expense. Issuing bonds typically takes at least 3–4 months. Bonds are generally more regulated and have more ongoing formal reporting and documentation requirements. Typically, loans are for a more limited time frame: 3, 5, 10, 12, or maybe 15 years. Bonds are typically 20–30 years. Repaying debt over a longer time period lowers the amount of debt repaid each month, thus lowering monthly costs, and increases the time over which interest is paid, thus increasing overall debt expense. Shorter loans increase the size of monthly payments. Longer loans and bonds increase overall interest costs. It is a tradeoff. Different loans and bonds will have differing requirements regarding how and how rapidly proceeds must be spent. Tax-free bonds generally require that bond proceeds be spent within several years of issuance. Taxable bonds do not have this requirement. This creates the option of borrowing money at a rate lower than those that are expected to be available in the future and then sitting on the money for several years. Even though you will have to pay interest on it, the lower interest rate may decrease the overall cost of the project.