HIGHER EDUCATION

Utilizing Financial Ratios to Determine Institutional Health

David A. DiIulis Principal, CPA, MBA, CGFM

10 April 2018

Many institutions utilize various operating and liquidity ratios to determine their overall financial health. One of the most popular resources that discusses appropriate measures in determining financial health is a publication called “Strategic Financial Analysis for Higher Education, Identifying, Measuring and Reporting Financial Risks” published in 2010 by Prager, Sealy & Co., LLC.

The publication cites four core ratio indicators contributing to the health of an institution. The specific core ratios were selected because they represent key components in relation to institution risk that should be addressed, even though other ratios could also be considered. Those four ratios are then combined into one score to determine overall financial health. The ratios assist in determining if the institution is financially healthy, whether it is better off than it was in the prior year, if it lived within its means, and whether it has the capacity to fulfill its overall mission.

The four core ratios are as follows:

Primary Reserve Ratio

addresses the institutions’ operating commitments. It determines whether resources are adequate and flexible enough to support the mission. The equity of the institution should grow in proportion to its operating size, which is determined by total expenses.

Viability Ratio

addresses debt obligations and whether resources are managed to advance the mission. The primary reserve ratio and viability ratio each use expendable net assets/net position as its numerator in the calculations.

Return on Net Assets / Net Position

measures whether asset performance and management support the strategic mission of the institution.

Net Operating Revenues Ratio

measures whether or not the operating results indicate if the institution is living within its own available resources.

These four ratios are combined into one score referred to as a composite financial index (CFI) by utilizing weighting and evaluation scales. Typically, the primary reserve and viability ratios are weighted more heavily (35{dbc2a7977897ed6bb279211f092ba1f542e4cbaf62b292c7a918387c014c548c} each) than the return on net assets and net operating revenue ratios (20{dbc2a7977897ed6bb279211f092ba1f542e4cbaf62b292c7a918387c014c548c} and 10{dbc2a7977897ed6bb279211f092ba1f542e4cbaf62b292c7a918387c014c548c} respectively).

The authors of the guide issued an update to the publication that addresses a variety issues, most notably the impacts of new FASB and GASB pronouncements on the ratios and how credit agencies view the changes in accounting pronouncements; further clarification on various computations of the ratios and discussion about using the ratios in trend and peer group analyses.

The update discusses how credit agencies are reviewing financial statements and the impacts of implementing GASB 68 Accounting and Reporting for Pensions and the impending implementation of GASB 75 Accounting and Financial Reporting for Post-Employement Benefits Other Than Pensions.  The update mentioned that many institutions are calculating the core ratios with and without the impacts of GASB 68 since it had such a huge impact on the net position of the organization. Many credit agencies are looking at the statements on a pre-GASB 68 basis and reviewing operating results based on a cash flow basis by adding back the non-cash pension expense rather than on operating results.  For FASB entities, ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities may require careful analysis in computing the core ratios, since the net asset classifications have been reduced from three classes to two.

One of the most common misconceptions in utilizing the ratios is comparing them among peer groups. No two institutions are identical; each has its own mission and overall goals. The author of the publication believes that a longitudinal analysis is much more meaningful, as it addresses specific issues within the institution that require addressing, which leads to more informed results. Additionally, reviewing an institution’s own ratios over time to monitor historical performance leads to a much more beneficial analysis.

 

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