A revenue requirement is the total amount of money a utility must collect from customers to pay all its costs, including its return on investment. To calculate a revenue requirement, a utility adds up various categories of costs of doing business included in what is known as a test year. The test year is a 12-month period that may be based on recent historical data, forecast data, or a combination of both.
A revenue requirement typically includes non-commodity expenses such as operations and maintenance (O&M) and administrative and general (A&G), depreciation, taxes, interest on debt, and authorized return (shareholder profit). The authorized return is determined by multiplying the amount of rate base financed through shareholder investment by the authorized return on equity. The rate base is the depreciated value of all the capital facilities the utility has constructed to provide services to its customers. The authorized return line item is the primary component of profit for an investor-owned utility. For non-profit utilities such as municipal utilities, public utility districts, and electric cooperatives there is no line item for authorized return in the revenue requirement. In most cases commodity costs such as gas or electric supply are excluded from a base revenue requirement since these costs are collected through a separate charge.
Revenue requirements are sometimes adjusted automatically between general rate cases either through a formula or through periodic regulatory filings. In some cases, costs not covered in an authorized revenue requirement are tracked in a balancing account and these amounts are reviewed in the next general rate case and, if approved, are included in a future revenue requirement. And in other cases, costs that are either less or more than what was approved in a rate case result in shareholder loss or gain.
Note that internal utility functions (such as transmission and distribution) will often each have their own revenue requirements. Added together, these result in a calculation of the utility’s overall revenue requirement.