UNDERSTANDING THE DEP ARTMENT OF EDUCATION S COMPOSITE SCORE. Ra ym o n d E. Kro u se, Jr., CP A

Transcription

1 UNDERSTANDING THE DEP ARTMENT OF EDUCATION S COMPOSITE SCORE Ra ym o n d E. Kro u se, Jr., CP A

2 WHAT IS A COMPOSITE SCORE?

3 WHAT IS A COMPOSITE SCORE? A measure of the relative financial health of an institution introduced as part of the Higher Education Act of 1965 While it measures financial health, it does not indicate educational quality of an institution Ratio is calculated from audited GAAP financial statements, but the Department of Education requires certain adjustments to amounts from financial statements The Department of Education s compliance requirement is found at 34 CFR Calculation of score for Not few unique differences Scores range from -1.0 to 3.0 -for -Profits vs. For -Profit schools similar but with a

4 WHAT IS A COMPOSITE SCORE? Composite score is a combined score of three separate financial ratios Primary Reserve Ratio Equity Ratio Net Income Ratio Each of these three ratios are weighted when they are combined Primary Reserve and Net Income are weighted at 30% and Equity at 40% for For - Profit schools Primary Reserve and Equity are weighted at 40% and Net Income at 20% for Not -for - Profit schools

5 PRIMARY RESERVE RATIO

6 PRIMARY RESERVE RATIO Represents a measure of a school s viability and liquidity For-Profit schools: Ratio adjusted equity divided by total expenses Not -for -Profit schools: Ratio expendable net assets divided by total expenses For For-Profit Schools Adjusted equity is calculated by taking equity and adding or subtracting various balance sheet line items Items subtracted from equity include: Intangible assets Unsecured related party receivables Net fixed assets Items added to equity include: Long -term debt (up to amount of net fixed assets) Post employment liabilities

7 PRIMARY RESERVE RATIO For Not -for -Profit Schools Expendable net assets are calculated by taking net assets and adding or subtracting various balance sheet line items Items subtracted from net assets include: Intangible assets Unsecured related party receivables Net fixed assets Permanently restricted net assets Items added to net assets include: Long -term debt (up to amount of net fixed assets) Post employment liabilities

8 PRIMARY RESERVE RATIO How to improve the Primary Reserve Ratio Securing related party receivables or having related party pay off receivable at year end Borrowing funds up to net property, plant and equipment Delaying large expenditures at year end that add both short increase expenses -term liabilities and

9 EQUITY RATIO

10 EQUITY RATIO Represents a measure of a school s capital resources and its ability to borrow For-Profit schools: Ratio of modified equity divided by modified assets Not -for -Profit schools: Ratio of modified net assets divided by modified assets Modified equity and modified assets are calculated by taking both equity and total assets and subtracting out a few different balance sheet line items including: Intangible assets Unsecured related party receivables Note that Modified Net Assets (or Equity for For -Profit schools) is NOT the same as Adjusted Net Assets (or Equity for For -Profit schools), which is used for the Primary Reserve Ratio due to different treatment with fixed assets and long - term debt

11 EQUITY RATIO How to improve the Equity Ratio Securing related party receivables or having related party pay off receivable at year end Paying down short -term liabilities (accounts payable and accrued expenses) at year end Note that the modified net assets (or equity), which are the numerator in the equity ratio, would not change by reducing cash and a payable. However, the denominator (Modified Assets) would decrease and produce a higher equity ratio. Delaying large expenditures at year end that add both short increase expenses Note that adding short -term liabilities and -term liabilities reduces the numerator and produces a lower ratio

12 NET INCOME RATIO

13 NET INCOME RATIO Represents a measure of a school s profitability Not -for -Profit school: Ratio of change in unrestricted net assets divided by unrestricted total revenue Does not consider temporarily restricted revenues For-Profit: Ratio of income before taxes divided by total revenues

14 NET INCOME RATIO How to improve the Net Income Ratio Both For -Profit and Not -for -Profit schools: Delaying expenditures that would affect net income Both For -Profit and Not -for -Profit schools: Increasing enrollment to generate increased tuition and auxiliary revenue Not -for -Profit schools: Soliciting unrestricted donations before year end

15 CALCULATING THE COMPOSITE SCORE

16 CALCULATING THE COMPOSITE SCORE Strength factor applied to all three ratios with a 3.0 being the highest strength factor a school can obtain for each of the strength factors Solid strength factors in one area may compensate for weaker strength factors in other areas

17 CALCULATING THE COMPOSITE SCORE The weighting of ratios differs for Not Weighting of ratios for a Not Primary reserve ratio 40% Equity ratio 40% Net income ratio 20% -for -Profit school Weighting of ratios for a For -Profit school Primary reserve ratio 30% Equity ratio 40% Net income ratio 30% -for -Profit and For -Profit schools

18 CALCULATING THE COMPOSITE SCORE Net Income Ratio is weighted higher for a For -Profit institution (income statement focus) than for a Not -for -Profit institution Primary Reserve Ratio is weighted higher for a Not -for -Profit institution (balance sheet focus) than for a For -Profit institution Equity Ratio carries the same weighted percentage for both the For -Profit and Not -for -Profit institutions

19 CALCULATING THE COMPOSITE SCORE Each strength factor is multiplied by the weighting factor to arrive at the three calculated ratios Strength factors are maxed out at 3.0 and then multiplied by the weighting factor For example in a NFP, the Primary Reserve and the Equity Ratio are weighted at 40% each so these two components of the composite score would be 1.2 each at their maximum scores. The Net Income Ratio is only weighted 20% so its maximum score can be.6.

20 CALCULATING THE COMPOSITE SCORE For example in a For Profit School, the Primary Reserve and the Net Income Ratio are weighted at 30% each so these two components of the composite score would be.9 each at their maximum scores. The Equity Ratio is weighted at 40% (same as a NFP) so its maximum score can be 1.2 The three ratios are added together to obtain your Composite Score Composite score cannot be higher than a 3.0 Let s run through some examples illustrating what we have discussed today

21 INTERPRETING THE COMPOSITE SCORE RESULTS

22 INTERPRETING THE COMPOSITE SCORE RESULTS Composite scores of : school is considered to be financially responsible and no further action is necessary Composite score of : school is considered to be in the zone and could face increased oversight by the Department of Education Schools can only be in the zone for three consecutive years Composite score of : schools are NOT considered to be financially responsible School must obtain a 1.0 in one of the next three years Schools must either provide a letter of credit of at least 50% of their prior year student financial aid amount (letter of credit alternative) Participate under a provisional certification and provide a letter of credit of at least 10% their prior year student financial aid amount OR

23 EFFECT OF FASB ASU ON COMPOSITE SCORE

24 EFFECT OF FASB ASU ON COMPOSITE SCORE For Years Ending May or June 30, 2019, ASU will be effective Categories of net assets to be changed to net assets without donor restrictions and net assets with donor restrictions Primary Reserve Ratio net asset categories need to be changed in the numerator of ratio and total expenses will be taken from new functional expense statement or equivalent for the denominator Equity Ratio net asset categories need to be changed in the numerator of ratio Net Income Ratio Change in Unrestricted Net Assets to be replaced by Change in net assets without donor restrictions in the numerator while Total unrestricted revenue to be replaced by total revenue and gains net assets without donor restrictions in the denominator

25 FINAL THOUGHTS ON COMPOSITE SCORE

26 FINAL THOUGHTS ON COMPOSITE SCORE Important to note many schools have debt covenant ratios to maintain that must be considered as well If entity is having an unusually strong financial year, you may consider writing off additional accounts receivable, incurring expenditures sooner than planned Better to have a 2.0 composite score for consecutive years than a 2.5 and a 1.5 Ratios are based on year end amounts so improving the balance sheet at year end is really the key Although composite scores are calculated at year end, best practice is for school to calculate more often to plan for year end action steps The Department of Education s calculation of composite score may differ from school s calculation Schools are encouraged to invest in capital and technology to improve the student s experience on campus (long -term approach)

27 FINAL THOUGHTS ON COMPOSITE SCORE Government Accountability Office (GAO) publishes composite scores for all NFP and Proprietary Schools -center/school/composite -scores 1,710 NFP schools listed and 1,970 proprietary schools. The NFP schools average score was 2.3 and the proprietary average was 1.9 Harvard University had a score of 2.2 while the Pittsburg Institute of Mortuary Science had a score of 3.0 as did the Boise Barber College GAO published their report in September 2017 and identified three key limitations to the composite score. Score does not consider changes in accounting practices during the past 20+ years Outdated financial measures Vulnerability to manipulation GAO noted in interviews that 7 of 10 schools were confused on how score was calculated

28 FINAL THOUGHTS ON COMPOSITE SCORE In addition to the composite score, the Department of Education evaluates an institution s financial responsibility by assessing whether school: Has sufficient funds to make timely refunds to students and the Department of Education Is meeting other financial obligations Is current on their debt obligations

29 PLEASE CONTACT ONE OF OUR EDUCATION SERVICE EXECUTIVES FOR MORE INFORMATION. Headquarters W. Die h l Rd. Su it e Nap e rville, IL Phone: Fa x: Our Expert Ray Kro u se J r., CP A Partner Phone: Fa x: ra y.kro u h.c o m

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