Coop Cash Reserves and Patronage Capital Strategies
Russ Hissom, CPA
Managing Your Electric Co-op's Patronage Capital Policy Is a Key Part of Financial Strategy
Electric cooperative financial strategies include the use of operating cash flows, cash reserves, debt, and customer investments — called patronage capital. What is patronage capital, and how can your cooperative establish a policy that maintains proper cash balances and cash flows while refunding capital credits to your member-owners?
Article Takeaways
- Patronage capital represents investments by electric co-op customers in the cooperative's equity and carries an ownership interest — including a vote in co-op operations.
- Establishing cash reserves is the first step in any policy development for co-op or utility financial management.
- Long-term co-op financial planning incorporates cash reserves, equity, capital improvements, rate changes, and debt issues for a holistic and comprehensive approach.
What Is Patronage Capital and How Does It Impact Electric Co-op Finances?
Electric cooperatives had their roots in the New Deal policies of the 1930s. When the Rural Electrification Administration (REA) began, funds were loaned to applicants to construct electric facilities in rural areas — rapidly growing the electrification of rural America. The REA later became part of the Rural Utilities Service (RUS), which remains the oversight body of many electric co-op financial and reporting matters.
The financing of electric cooperatives was — and is — a mixture of loans from the REA/RUS, electric rates, and patronage capital. Patronage capital is the amount invested in the co-op by customers through their electric rate payments.
After determining that the cash flow needs of the co-op have been met and that adequate cash reserves exist to serve customers, the margin on sales is allocated annually to each member's patronage capital account. A balance of patronage capital represents ownership in the electric co-op and carries a vote in the operation of the co-op.
The Patronage Capital Process
Many electric co-ops have policies where a portion of a customer's patronage capital is returned to them in years where earnings exceed budgets. This is called the retirement of patronage capital — also referred to as returning capital credits.
Best Practices in Cash Reserve Balances — Calculating Optimal Cash Flow Needs
Whether your organization is a co-op, public power utility, or investor-owned utility, establishing proper cash reserves is the foundation of sound financial management. The formula for calculating reserve needs is:
Cash reserves serve multiple purposes: they build equity (minimizing debt requirements), provide funds for capital projects, and give the co-op a buffer to mitigate rate increases in volatile years.
Cash Reserves and the Bond Rating Agencies
A good benchmark for unrestricted cash reserve needs comes from metrics published by bond rating agencies. Moody's Investor Service uses days cash on hand as a factor in determining bond ratings. Unrestricted cash on hand is calculated as:
| Moody's Rating Category | Rating Symbol | Minimum Days Cash on Hand | Interpretation |
|---|---|---|---|
| Exceptional | Aaa | 250+ days | Highest quality; extremely strong capacity to meet financial commitments |
| Very Strong | Aa | 150 days | High quality; very strong financial capacity — Moody's minimum for "Aa" rating |
| Above Average | A | 100 days | Strong capacity; somewhat susceptible to adverse conditions |
| Adequate | Baa | 60 days | Adequate financial capacity; more exposure to adverse economic conditions |
| Speculative | Ba and below | < 60 days | Speculative elements; subject to substantial credit risk |
Cash Reserves Calculation Example — Member Service Cooperative
The following scenario illustrates the calculation of minimum and optimal cash reserves:
| # | Item | Annual Amount |
|---|---|---|
| 1 | Co-op Operating Expenses | $40,000,000 |
| Purchased Power | $20,000,000 | |
| 2 | Depreciation Expense (recovered in rates) | $5,000,000 |
| 3 | Routine Capital Improvements (current year) | $5,000,000 |
| 4 | Annual Debt Service | $4,000,000 |
| 5 | Additional Capital Projects Funded from Reserves | $2,000,000 |
| Total Annual Operating & Maintenance Expenses (for Days Cash formula) | $60,000,000 | |
Using these figures, the daily cash requirement is $60,000,000 ÷ 365 = $164,384 per day. The minimum (30-day) and optimal (150-day Moody's "Aa" threshold) reserve targets are calculated as follows:
| Daily Cash Requirement | $164,384 |
| × Days of Coverage | 30 days |
| = Minimum Cash Reserve Need | $4,931,507 |
| + Capital Projects (reserves-funded) | $2,000,000 |
| Total Minimum Reserve Target | $6,931,507 |
| Daily Cash Requirement | $164,384 |
| × Days of Coverage | 150 days |
| = Target Unrestricted Cash | $24,657,534 |
| + Capital Projects (reserves-funded) | $2,000,000 |
| Total Optimal Reserve Target | $26,657,534 |
Each organization will approach cash reserves differently. The reserve philosophy reflects the risk tolerance of management and the Board, as well as the decades of embedded history of the organization.
Allocating Margins to Each Member's Patronage Account
A simple and consistent approach to allocating the annual margin to each member's patronage capital account uses a two-step formula:
The member's share of patronage capital is credited to their patronage capital account and tracked by year of the margin allocation — this annual tracking is essential for properly administering FIFO retirement.
Retiring Patronage Capital
Patronage capital can be retired (returned) to both current co-op members and former members. The Board of Directors reviews financial results and approves the return of patronage capital. The most common method is FIFO (first in, first out) — members with the oldest patronage capital balances receive a refund check first, and their equity is removed from the patronage capital account in the general ledger.
As an example, Basin Electric Cooperative — a $2 billion electric cooperative — returned $64.5 million to members in 2021 through a combination of rate refunds and retirement of capital credits. This philosophy rewards both current ratepayers for their system contributions and legacy capital credit holders for their past investments in the co-op. The key is a Board policy that establishes a consistent, documented approach to retirement — one that the membership understands and supports.
The Electric Co-op Financing Model
The electric co-op financing model uses the proven combination of equity and debt. Cash reserves and patronage capital are the tools to manage the equity portion of the equation. The key is to incorporate reserve planning, patronage capital policy, electric rates, capital additions, and debt issuance into the co-op's long-range financial plan. A written policy with Board approval is essential to a smooth, transparent, and member-beneficial process.
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Disclaimer: The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists, LLC. You should seek formal advice on this topic from your accounting or legal advisor.