Financial analysis. Using financial statements to measure performance at. Michigan State University. MSU s financial statements Analyzing performance

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Financial analysis Using financial statements to measure performance at Michigan State University MSU s financial statements Analyzing performance

1 Financial analysis Using financial statements to measure performance at Michigan State University MSU s financial statements Analyzing performance Professor Kirt C. Butler Department of Finance Broad College of Business Michigan State University November 23, 2015 Michigan State University, 2012

2 MSU Financial Stewardship Practices Support educational, research, and outreach programmatic needs. Recurring expenses should be funded with recurring revenues. Include funding for future needs using long-term financial framework to determine multi-year budgets. Deploy diverse revenue streams for funding programmatic needs, including donations and research activities. From a presentation by Mark Haas to the Board of Trustees Audit Committee, October 29,

3 Fiscal Year Financial Overview The University has once again received a clean external audit opinion. Overall, MSU s financial position remains strong with a total of $3.4B in net position. Net position increased $206M (6.5%) primarily due to revenues from tuition, grants and contracts, and gifts. MSU continued to manage through uncertain impacts of state and federal budget constraints. From a presentation by Mark Haas to the Board of Trustees Audit Committee, October 29,

4 Fiscal Year Financial Overview (Continued) Fiscal year tuition revenue increase reflects changes in rates, student credit hours and shifts in enrollment mix. Long-term trends have tuition rates + state appropriation revenues expected to grow at rate of inflation. Development of Facility for Rare Isotope Beams (FRIB) continues with $101M in state and federal funds received in current year ($233M project to date). Empower Extraordinary campaign commitments now total over $1B. From a presentation by Mark Haas to the Board of Trustees Audit Committee, October 29,

5 Financial statements GASB vs restated Statement of Net Position Balance sheet - Measures an organization s assets and the sources of funds used to buy or build those assets Statement of Revenues, Expenses and Changes in Net Position Income statement - Measures operating performance during a period of time, such as the most recent fiscal year 5

6 The main balance sheet accounts Total assets = Liabilities & Net Worth Current assets Cash & equivalents Receivables Inventories Long-term assets Tangible assets (land, plant, equipment) Intangible assets Intellectual property Brand name, franchise Current liabilities Accounts payable (e.g., wages, taxes) Short-term debt Long-term liabilities Long term debt Capitalized leases Net worth (Net assets or position) 6

7 Items in the balance sheet Warning! Book value does not necessarily equal market value Book values for current assets and liabilities typically are close to market values (with the exception of inventory) Book values for long-term financial liabilities also typically are close to their market values Book values for long-term assets typically are valued at historical cost (with an adjustment for depreciation) and seldom reflect their market values 7

8 The main income statement items Revenues Costs of goods sold Selling, general and administrative expense Depreciation (a non-cash charge) EBIT (earnings before interest and taxes) Interest expense Taxable income Tax Net income Dividends Added to retained earnings (or net position) 8

9 Items in the income statement Warning! Accounting income and expenses do not necessarily equal cash flow Accounting values usually are close to cash flows But sometimes there are important differences - Overhead expenses (e.g., fringe benefits) might not be included - Other??? 9

Financial analysis at MSU To evaluate ongoing operations - achieve comparability over time - achieve comparability across institutional units (either MSU-v-competitor or unit-v-unit within MSU) -

10 Financial analysis at MSU To evaluate ongoing operations - achieve comparability over time - achieve comparability across institutional units (either MSU-v-competitor or unit-v-unit within MSU) - use financial ratios to make decisions To forecast and prepare for the future - forecast the sustainability of net income and cash flow - anticipate changes in investments - identify financing needs 10

MSU is near the top in B1G enrollment 60000 50000

11 MSU is near the top in B1G enrollment IPEDS reporting 11

12 MSU lags in revenues, assets, and net worth 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - Total assets Net worth Revenues Maryland and Rutgers not shown IPEDS reporting 12

13 MSU operating revenues & expenses ($ millions) 2,500 2,000 1,500 1,000 2,346 2,163 2,051 1,967 2,204 1,878 1,893 2,060 2,110 1,746 1,786 1,966 1,572 1,613 1,897 1,798 1,830 1,714 1,455 1,333 1,365 1,277 1,248 1,299 1,306 1,401 1,497 1,

14 Increasing reliance on tuition revenue ($ mil) 14

15 Statement of Net Position ($ millions) Current Assets: Cash and cash equivalents Investments Collateral from securities lending Accounts and interest receivable, net Student loans and pledges receivable, net Inventories and other assets Total current assets

16 Statement of Net Position ($ millions) Noncurrent Assets: Restricted cash and cash equivalents Restricted investments Endowment investments 1,395 1,369 1,584 2,082 2,242 Other investments Student loans and pledges receivable, net Investments in joint ventures and other Derivative instruments - swap asset Deferred outflows of hedging derivatives Unamortized bond origination costs Capital assets, net 1,703 1,819 1,901 1,995 2,107 Total noncurrent assets 3,707 3,664 4,014 4,399 4,878 Total assets 4,135 4,108 4,527 4,906 5,412 Deferred Outflows of Resources

17 Statement of Net Position ($ millions) Liabilities and Net Assets: Current liabilities: Accounts and interest payable Accrued personnel costs Obligations under securities lending Accrued self-insurance liabilities Payroll taxes and other payroll deductions Deposits held for others Unearned revenues Current long-term debt & other obligations Total current liabilities

Statement of Net Position ($ millions) 2011 2012 2013 2014 2015 Noncurrent liabilities: Accrued personnel costs 32 33 34 34 33 Accrued self-insurance liabilities 7 7 8 6 7 Derivative instruments -

18 Statement of Net Position ($ millions) Noncurrent liabilities: Accrued personnel costs Accrued self-insurance liabilities Derivative instruments - swap liability Net other postemployment benefit obligati Long-term debt and other obligations ,091 Total noncurrent liabilities 1,003 1,077 1,275 1,302 1,536 18

19 Statement of Net Position ($ millions) Net Assets: Invested in capital assets, net of related debt ,055 Restricted - Nonexpendable Restricted - Expendable Unrestricted ,029 1,103 Total net assets 2,724 2,677 2,825 3,173 3,379 Total liabilties and net assets 4,135 4,191 4,588 4,966 5,474 19

Statement of Net Position ($ millions) 2011 2012 2013 2014 2015 Change Assets Current assets 428 444 513 507 534 27 Noncurrent assets 3,707 3,664 4,014 4,399 4,878 479 Total assets 4,135 4,108 4,527

20 Statement of Net Position ($ millions) Change Assets Current assets Noncurrent assets 3,707 3,664 4,014 4,399 4, Total assets 4,135 4,108 4,527 4,906 5, Deferred Outflows of Resources Liabilities Current liabilities Noncurrent liabilities 1,003 1,077 1,275 1,302 1, Total liabilities 1,411 1,514 1,763 1,793 2, Net position Net investment in capital assets , Restricted nonexpendable Restricted expendable Unrestricted ,029 1, Total net assets (position) 2,724 2,677 2,825 3,173 3,

21 Big Ten Net Position $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 $13.1 (Billions) Big Ten Peers $10.7 MSU 2014 $7.7 MSU 2015 incremental increase $6.6 $4.4 $4.2 $3.8 $3.6 $3.6 $3.6 $3.4 $3.1 $3.1 $1.8 $3.2 Note: Amounts listed are fiscal year 2014 totals, except for MSU which lists both fiscal year 2014 ($3.2B) and 2015 ($3.4B) totals. Unless otherwise noted, amounts represent consolidated financials of the University and may include multiple campuses, if applicable. 21

22 Millions Assets Increased $506 Million $5,500 $4,500 $5,412 $4, $ Change 184 Cash and investments (includes unspent bond proceeds) $3,500 2,317 2, Receivables, inventories, and other $2,500 $1, Long-term investments (including new gifts and transfers from short-term investments) $500 1,995 2, Capital assets (land & buildings) $(500) FY FY Total 22

23 Millions Liabilities Increased $302 Million $2,100 $1,800 $1,500 $1,200 $2, $ Change $1, (4) 307 Accounts payable Other liabilities (self insurance, payroll taxes) Personnel costs (sick and vacation accrued time) $ Revenue received in advance of services provided (summer school, athletic tickets) $600 1,074 1, Interest rate swaps liability OPEB $ Debt $- FY FY Total 23

24 Millions Unrestricted Net Position Increased $74 Million $1,400 $1,200 $1,000 $800 $600 $400 $200 $1, $1, $ Change (24) (1) QUASI/TERM ENDOWMENT INVESTMENTS: Represent expendable funds that by Board designation, the principal may not be expended. RETIREMENT AND INSURANCE: Includes reserves for post-employment health benefits and the University s Noncontributory Retirement Program (UNCRP). DEPARTMENTAL WORKING CAPITAL: Represents balances designed to ensure the stable, efficient operations of University departments. PROGRAMMATIC COMMITMENTS: Represents funds provided for commitments and projects which generally will be completed within the subsequent fiscal year. CAPITAL AND INFRASTRUCTURE: Includes reserves for various University building, infrastructure, and programmatic needs related to construction and technology changes. $- $(200) $(400) (43) UNCOMMITTED: Represent general fund funds not specifically designated. Amount would fund approximately 1 day of operating expenses. OTHER POST-EMPLOYMENT BENEFITS (OPEB): Includes accumulated annual OPEB accrual. $(600) FY FY Total 24

25 Big Ten Unrestricted Net Position $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 (Billions) $6.3 Big Ten Peers MSU 2014 MSU 2015 incremental increase $3.4 $3.2 $2.0 $1.5 $1.5 $1.5 $1.4 $1.1 $0.8 $0.7 $0.7 $1.0 $0.4 $0.4 Note: Amounts listed are fiscal year 2014 totals, except for MSU which lists both fiscal year 2014 ($1.0) and 2015 ($1.1) totals. Unless otherwise noted, amounts represent consolidated financials of the University and may include multiple campuses, if applicable. 25

26 MSU s Sources and Uses of Funds Sources of funds MSU influenced Tuition and fees Self-supporting activities Spending policy distributions General fund carry-forwards Debt proceeds Gifts and grants External influenced Investment income State appropriations Uses of funds MSU influenced Employee wages & benefits Construction spending Financial aid Vendor expenses External influenced Investment loss 26

27 Statement of Revenues, Expenses and Changes in Net Assets ($ millions) Operating Revenues: Student tuition and fees, net of allowance State of Michigan grants and contracts Federal grants and contracts Local and private sponsored programs Interest and fees on student loans Departmental activities Auxiliary activities Operating revenues 1,389 1,504 1,578 1,620 1,742 27

28 Statement of Revenues, Expenses and Changes in Net Assets ($ millions) Operating Expenses: Instruction and departmental research Research Public service Academic support Student services Scholarships and fellowships Institutional support Operation and maintenance of plant Auxiliary activities Depreciation Other expenses, net Operating expenses 1,858 1,931 2,024 2,069 2,167 Operating loss (469) (427) (446) (449) (425) 28

29 Statement of Revenues, Expenses and Changes in Net Assets ($ millions) Nonoperating Revenues (Expenses): State operating appropriations State agriculture experiment station appropriation State cooperative extension service appropriation State appropriated federal fiscal stabilization funds Federal Pell grant revenue Gifts Net investment income (loss) 289 (22) Interest expense on capital asset related debt (39) (35) (36) (41) (37) Other nonoperating revenues, net Net nonoperating revenues Income (loss) before other revenues 221 (93)

30 Statement of Revenues, Expenses and Changes in Net Assets ($ millions) Total operating revenues 1,389 1,504 1,578 1,620 1,742 Total operating expenses 1,858 1,931 2,024 2,069 2,167 Net operating income (loss) (469) (427) (446) (449) (425) Net nonoperating revenues Income (loss) before Other 221 (93) State capital appropriations Capital grants and gifts Additions to permanent endowments Increase (decrease) in net position 256 (47)

31 Accounting and common sense 2014 GM annual report (p. 26) Restated operating performance Operating Cash Flow $10,132 Less: Capital Expenditures and Adjustments -$6,986 Automotive Free Cash Flow $3,146 Management believes these non-gaap measures provide meaningful supplemental information regarding GM s operating results and liquidity because they exclude amounts that management does not consider when assessing and measuring operational and financial performance (They are) used by management in its financial and operational decision-making. Similarly, Mark Haas restated MSU s operating results in his 2014 report to the Board of Trustees 31

32 Operating statement ($ millions) Revenues: Change Student tuition and fees, net of allowance State of Michigan grants and contracts Federal grants and contracts (including Pell) Local and private sponsored programs Interest and fees on student loans Departmental activities Auxiliary activities State appropriations (including AgBio, & MSUE) Gifts Capital grants, gifts, and appropriations Additions to permanent endowments (7) Investment income budgeted for operations Other revenues, net (5) Subtotal - revenues 1,893 1,967 2,051 2,163 2,

33 Operating statement ($ millions) Expenses: Change Instruction and departmental research Research Public service Academic support Student services Scholarships and fellowships Institutional support Operation and maintenance of plant (10) Auxiliary activities Depreciation Interest expense on capital asset related debt (4) Other expenses, net (2) Subtotal - expenses 1,897 1,965 2,061 2,110 2, MSU resources are mission focused. FY14-15 amount totals $1.3b (an increase of $68m) and represents over 60% of total expenses. 33

34 Operating statement ($ millions) Change Operating revenues 1,893 1,967 2,051 2,163 2, Operating expenses 1,897 1,965 2,061 2,110 2, Net, before investments (4) 2 (10) Net investment income (loss) 260 (49) (231) Net income (loss) 256 (47) (142) 34

35 Auxiliary activities - important to the mission of MSU Major auxiliary activities as a component of overall University revenues/expenses RHS 10% Health Team 4% Athletics 4% Instruction, Research, Outreach, and other activities 82% 35

36 Major Auxiliary activities historical trend (in millions) $300 $250 $200 $150 $100 $50 $0 $125 $100 $75 $50 $25 $0 RHS $242 $239 $241 $237 $251 $245 $222 $ Athletics $103 $97 $88 $87 $76 $81 $75 $ * $125 $100 $75 $50 $25 $0 Revenues Expenses and Net Transfers MSU HealthTeam $104 $104 $104 $109 $106 $105 $106 $ * In , MSU improved the reporting of athletic game guarantees/settlement payments for more consistency with peer institutions. $7M of game guarantee payments previously reported as negative revenue, is now reported as an expense. In addition, sports broadcasting, sponsorships and conference distributions increased. 36

37 37

38 Financial statement analysis Financial statement analysis uses ratios and other simple measures to evaluate the financial health and performance of an organization at a point in time or over time relative to peer institutions or relative to expectations for planning and strategy purposes 38

39 Ratios and common sense Many ratios are available to measure financial health Liquidity = our ability to meet short-term needs Efficiency = output / input Leverage = impact of debt on the balance sheet Performance = have we met expectations? We need to use common sense in selecting which ratios to use in financial analysis. Ratios that are relevant for one entity (e.g., an MSU unit) may not be relevant for measuring financial health at another unit, and vice versa. 39

40 Ratios and common sense 40

41 Measuring financial health at MSU Ratios used in Higher Ed to evaluate ongoing operations * Primary reserve ratio (in years) = Total expendable net assets / Total expenses Net operating revenue ratio (%) = Total income / Total revenues Viability (or coverage) ratio (%) = Total expendable net assets / Total LT debt Return on net assets ratio (%) = Change in net assets / Total net assets Composite financial index Resource sufficiency Operating results Leverage Asset management Overall financial health * Strategic Financial Analysis for Higher Education, 7e, 2010, by Prager, Sealy & Co. LLC, KPMG LLP, and Attain LLC. 41

42 Primary reserve ratio = Total expendable net assets / Total expenses measures how long we could operate using expendable reserves A higher primary reserve ratio indicates a greater ability to meet short-term operating and financial obligations MSU s 2015 ratio of 0.81 years (or nearly 10 months) is near the median for B1G universities This liquidity measure indicates that MSU could fund about ten months worth of expenses with the expendable net assets currently on hand 42

43 Primary reserve ratio = Total expendable net assets / Total expenses measures how long we could operate using expendable reserves Total expendable net assets Total expenses Primary reserve ratio (in months) Median =

44 Primary reserve ratio versus B1G (2011 ) 44

45 Net operating revenue ratio = Total operating & nonoperating income / Total revenues measures if operating activities provided a surplus or deficit MSU s 2015 ratio of 0.10 or 10% is firmly a surplus A surplus is desirable, but a large surplus might not be desirable if it means we are not contributing to our mission This ratio is volatile for all universities because it varies with investment performance & not just operations MSU s Investment Spending Policy uses a 5-year average, and the 2015 net operating revenue ratio is close to our historical performance 45

46 Net operating revenue ratio = Total operating & nonoperating income / Total revenues measures if operating activities provided a surplus or deficit Total oper/nonoper income (267) (12) Total revenues Net operating revenue ratio (0.18) (0.01) Median =

47 Net operating revenue ratio versus B1G (2011 ) 47

48 Return on net asset ratio = Change in net assets / Total net assets (beginning-of-year) a measure of the total return on investment of net assets for the year MSU s 2015 ratio of 6% is similar to our B1G peers and typical of our recent performance Deficits are bad, but we also need to pursue our mission This ratio is volatile for all universities because it varies with investment performance & not just operations MSU s Investment Spending Policy considers our 5-year investment performance when determining how much of our investment earnings to make available for operations 48

49 Return on net asset ratio = Change in net assets / Total net assets (beginning-of-year) a measure of the total return on investment of net assets for the year Change in net assets (290) (47) Total net assets Return on net assets ratio (0.11) (0.02) Median =

50 Return on net assets versus B1G (2011 ) 50

51 Viability (or coverage) ratio = Total expendable net assets / Total long-term debt measures the availability of expendable net assets to payoff debt MSU s 2015 ratio of 1.6 means that we have enough in expendable net assets to pay off debt 1.6 times The 5-year average is expendable net assets of 1.5 times debt This measure is important because it influences our bond rating and cost of borrowing Debt was reduced by $39 million in , after increasing by $200 million in to fund infrastructure Other 7% CP development. 15% FY Bonds 78%

52 Viability (or coverage) ratio = Total expendable net assets / Total long-term debt measures the availability of expendable net assets to payoff debt Total expendable net assets Total long-term debt Viability ratio Median =

53 B1G Viability ratios versus B1G (2011 ) 53

54 Moody s B1G Credit ratings (S&P ratings are similar) Aaa Aa1 Aa2 Aa3 as of 11/17/

55 Debt Increased $231 Million FY FY $ Change (Amounts in Millions) CP 15% Other 7% FY Bonds $ 844 $ 1,018 $ 174 Commercial Paper (CP) Other Debt (e.g. campus-based student loans and bond premiums) Total Debt $ 1,074 $ 1,305 $ 231 Bonds 78% Change in debt summary (in millions): Bonds CP Other Total Debt issued for: Residential halls and facilities $ 57 $ 19 $ - $ 76 Research facilities Athletic facilities Other auxiliary facilities (Parking) Utilities and infrastructure Refunding of debt Original issue premium A Debt reduced by: Scheduled debt service payments (19) (12) (2) (33) Refunding of debt - (54) - (54) Net change in debt $ 174 $ 44 $ 13 $ 231 CP 14% Other 8% FY Bonds 78% 55

56 Average cost of capital is 3.4% Debt Portfolio FY FY $ Change (in millions) Fixed Rate $ 721 $ 908 $ 187 Variable Rate - CP Traditional Variable Rate Synthetic Fixed Rate (1) Total Debt $ 1,074 $ 1,305 $

57 Composite Financial Index (CFI) The Composite Financial Index (CFI) is a weighted average of the other 4 ratios, composed of strength factors and index weights. For MSU, it is calculated as: Composite Financial Index (CFI) = ( Primary reserve ratio / ) * ( Net operating revenues ratio / ) * ( Return on net assets ratio / ) * ( Viability ratio / ) *

58 Composite Financial Index (CFI) The Composite financial index (CFI) is a weighted average of the other four ratios CFI range Recommended action * -1 to 1 Assess the viability of the institution s survival 0 to 2 Reengineer the institution 2 to 4 Direct resources toward transformation 4 to 6 Focus resources to compete MSU 6 to 8 Experiment with new initiatives > 8 Deploy resources to achieve a robust mission * Fitzgerald, Moody s Ratings Approach for Private Colleges and Universities, (Moody s Investors Services, 1999). 58

59 Composite financial index (CFI) a weighted average of the other four ratios This ratio also varies with investment performance & not just operations because it is a function of the other ratios MSU s 2015 ratio of 5.4 is solidly in the focus resources to compete category Our CFI also compares favorably to our B1G peers We must continue to work on our outputs and processes in order to achieve continued success 59

60 Composite financial index (CFI) a weighted average of the other four ratios Primary reserve Net operating Return on net assets Viability CFI SCORE Median =

61 Composite Financial Index (CFI) versus B1G (2011 )

62 Allocating financial resources to mission What is the mission? Are resources sufficient and flexible? Does financial asset performance support the strategic direction? Do operating results indicate the institution is living within available resources? Is debt managed strategically to advance the mission? Priorities must be set! Critical to the mission Very important to the mission Important to the mission Less important to the mission Not important to the mission 62

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{Michigan Community College Association}

{Michigan Community College Association} Trustees Summer Institute July 23, 2015 Agenda Understanding College Funds 2 Revenue Sources and Expense Classification Statement of Net Position Reading the Financial