Assessing Your Institution’s Financial Health Using the … · Assessing Your Institution’s...

Assessing Your Institution’s

Financial Health Using the CFI

FOCUS

Virginia Commonwealth University

November 14, 2014

Larry Goldstein, President, Campus Strategies, LLC

November 14, 2014© Campus Strategies, LLC 1

BACKGROUND


Background

US higher education ratio analysis initially

relied on data collected through HEGIS—

Higher Education General Information

Survey (US Department of Education)

◦ HEGIS began in 1966 and continued until

1987 when it was replaced by IPEDS—

Integrated Postsecondary Education Data

System

No utilization of financial statements for

ratios until 1995…


Background

Ratio Analysis in Higher Education, fourth

edition (1999) by KPMG and Prager, McCarthy

& Sealy, LLC—a significant advance

◦ Introduced

Strategic Resource Allocation matrix

Composite Financial Index (CFI)

Combining selected ratios to produce

overall score

◦ Relevant only to private institutions…


Background

Fifth edition (2002) applied CFI to public

institutions

◦ New concepts

Adaptation of ratios to reflect then-new

GASB reporting model

Inclusion of FASB support organizations in

ratio calculations…


Background

Seventh edition released summer 2010

◦ Extends scale for CFI

◦ Revisions to ratios

Drops alternative to net operating

revenues ratio for private institutions

Requires the establishment of an

operating measure—whether or not

reported externally…


Background

◦ Significant emphasis on liquidity due to

impact of Great Recession on higher

education—introduces new ratio

◦ Encourages averaging ratios over multiple

years

◦ Deemphasizes peer comparison in favor of

trend analysis—assess institution over time,

not against others

◦ Encourages projecting ratios for strategic

purposes…November 14, 2014© Campus Strategies, LLC 7

CONTEXT


Context

Why calculate financial ratios?

From the sixth edition, “We believe the fundamental concept of assessing financial health by using a limited number of ratioshas improved the financial health of colleges and universities.” (emphasis added)

Just as important, it helps non-accountants understand institutions’ financial health…


Context

Ratios are valuable for those who do not

understand how to interpret and analyze

higher education financial statements

Trustees, faculty, students, and other

interested parties can use the ratios to gain

an understanding of the institution’s

financial health…

Reduces complexity of GAAP-basis financial

statement analysis…


Context

Facilitates peer assessment

Shifts focus to a more global level

Supports strategic decision making

Demonstrates financial impacts of key

decisions

Assists with performance assessment

◦ Creditworthiness

◦ Relative liquidity, financial viability, and

leverage of resources

◦ Financial assets’ performance…


Context

Principles

◦ Use ratios to measure acquisition / use of

resources in support of mission

◦ Focus on summary information to address

key questions

◦ Present a select number of ratios to

provide answers

Additional detail when necessary…


Context

◦ Focus on trends in ratios

Some trends are evident from internal

examination / review

Other trends arise through comparisons

with others

Never make decisions based on

comparison to other institutions using

CFI—only underlying ratios •


Questions?


COMPOSITE FINANCIAL INDEX (CFI)


CFI

Combines four principal ratios

Primary reserve ratio

Viability ratio

Return on net assets ratio

Net operating revenues ratio…


Ratios

◦ Standard weighting for each ratio, but can

be adapted for unique situations

Weighting should remain fairly static over

time

In addition to four principal ratios, seventh

edition presents 13 secondary ratios…


Ratios

Primary reserve ratio—35 percent

◦ Indicates the sufficiency of resources and

their flexibility

Expendable net assets / total expenses

Unless otherwise specified, expendable

net assets restricted for plant purposes

are excluded…


Ratios

Viability ratio—35 percent

◦ Indicates the capacity to repay total debt

through reserves

Expendable net assets / long-term debt…


Ratios

Return on net assets ratio—20 percent

◦ Indicates whether the institution is better

off financially this year than last

Change in net assets / beginning net

assets…


Ratios

Net operating revenues ratio—10 percent

◦ Indicates whether institution is living

within available resources

Operating surplus or deficit / operating

revenues



10

10

10

103

33

3

PRIMARY RESERVE RATIO

NET OPERATING REVENUESRATIO

VIABILITY RATIO

RETURN ON NET ASSETS RATIO

GRAPHIC FINANCIAL PROFILE

Threshold Values

Financial health pegged at 3, equating to

Primary Reserve: 140 days of operations

Actually more due to depreciation

Viability: 1.25 times total debt owed

Return on Net Assets: 6% return on

combined financial / nonfinancial assets

Net Operating Revenues: 2% net surplus

to increase reserves •


Questions?


OTHER ISSUES


Other Issues

What to do about affiliated entities

◦ Include them!

Necessary for a comprehensive picture

of the institution and its operations

◦ GASB Statement No. 39 (component units)

facilitated this by requiring inclusion of

significant entities

What about omitted entities—due to

criteria or significance?...


Other Issues

◦ Potential problem with double-counting of

some items

Disbursements from foundation to

institution is treated as expense by

foundation and, once expended by

institution, as expense by institution

Consolidation would address through

elimination, but not always available…


Other Issues

Comparisons between institutions

◦ Very risky due to inconsistencies

Especially between public and private

◦ Helps if institutions have similar mission

◦ Optimal comparison occurs within affinity

groups

Examples include ACC, VCCS institutions,

etc…


Other Issues

Limitations / pitfalls of financial ratio analysis

◦ It is not a substitute for understanding the

financial statements themselves; it shines a

light on the statements’ content but can’t

tell the entire story

◦ It should not be used to mask poor

financial performance

◦ It is but one quantitative measure…


Other Issues

◦ Appropriate assessment—financial or

otherwise—requires both quantitative and

qualitative analysis

Financial ratios should not be used as a

substitute for qualitative judgments

It should be supplemented with other

factors…


Other Issues

◦ Peer comparisons without longitudinal

analysis can be misleading

◦ Longitudinal analysis without peer

comparisons can be misleading

Five-year periods seem to work well

Consistently applied ratio analysis is

essential •


Resources

Strategic Financial Analysis for Higher Education,

seventh edition, by Prager, Sealy & Co., LLC,

KPMG LLP, and Attain LLC

◦ Available through KPMG or NACUBO

www.nacubo.org


Using Financial Ratios to Assess

Institutional Financial Health

Questions, Comments,

and Reactions

[email protected]

(540) 942-9146


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