Composite Financial Index*

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Penelope Rose
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1 Composite Financial Index* The composite financial index (CFI) is a measure of financial health used widely throughout higher education. It relies on information from audited financial statements and utilizes four core ratios measuring various aspects of an organization s financial well being. The ratios are the primary reserve ratio, the viability ratio, the return on net assets ratio, and the net operating revenues ratio. The four ratios are weighted and combined to determine the CFI. Each ratio is discussed below. The primary reserve ratio, representing 35 percent of the CFI, measures an institution s financial health by comparing accumulated reserves to annual operating demands. It is calculated by dividing expendable resources at the end of a period by the operating expenses incurred during that period. Expendable resources are those representing financial net assets or the institution s financial equity. Excluding physical assets such as buildings and equipment (and financial resources restricted for plant purposes), what is owed by an institution is subtracted from what is owned by the institution and the balance represents its net assets. Operating expenses are the amounts invested to pay the annual costs (e.g., salaries, utilities, supplies) related to instruction, institutional support, student services, etc. By comparing the two, it is possible to determine how long an institution could conduct operations if no new revenues were being generated. Minimal financial health for the ratio is deemed to be.4, representing approximately 140 days or one semester of operating expenses. The maximum value credited when calculating the CFI is 500 days of operating expenses, meaning an institution could operate for 1.4 years without generating revenues. The viability ratio, also representing 35 percent of the CFI, is a corollary to the primary reserve ratio. It also utilizes expendable resources to calculate the ratio. But instead of focusing on operating demand, as represented by operating expenses, it utilizes the long-term debt related to facilities. To calculate the viability ratio, expendable resources are divided by the total amount of debt and other obligations related to facilities typically in the form of bonds, capital leases, or asset retirement obligations. The ratio indicates the amount of debt that could be repaid just from reserves. Minimal financial health for the ratio is 1.25, meaning that reserves exceed total obligations by one quarter. The maximum value credited when calculating the CFI is 4.2, meaning reserves exceed total obligations by a factor of just over four. The return on net assets ratio, representing 20 percent of the CFI, indicates whether an institution is better off at the end of a period than at the beginning. The ratio is calculated by dividing the change in total net assets for the period by the beginning net assets for the period. Minimal financial health for the ratio is a 6 percent return on net assets, meaning that net assets have increased during the year by 6 percent of the net assets at the beginning of the year. The maximum value credited when calculating the CFI is 20 percent. Campus Strategies, LLC Page 1 of 2

2 The final ratio the net operating revenues ratio, representing 10 percent of the CFI indicates whether an institution was able to conduct operating activities by using just the operating revenues generated during the period. An institution able to do this will contribute to reserves by generating more operating revenues than operating expenses. Operating revenues include things like tuition, fees, grants, endowment income available for spending, and non-endowment gifts. (Endowment gifts are revenues but they are not available for operations.) The ratio is calculated by dividing the net operating revenues by the operating revenues. In other words, after subtracting operating expenses from operating revenues, the remaining amount is divided by operating revenues. Minimal financial health for the ratio is 2 percent, meaning that operating revenues exceed operating expenses by 2 percent of operating revenues. The maximum value credited when calculating the CFI is 7 percent. The combination of the four ratios results in a CFI score on a ten-point scale. A score of three represents minimal financial health and equates to the minimums described above for each ratio. Scores below three, including negative scores, are an indication of financial stress. Higher scores, for instance those above six, indicate that the institution enjoys strong financial health and would be able to weather financial difficulties and/or invest in new programs and activities. * See Strategic Financial Analysis for Higher Education, Seventh Edition, by Prager, Sealy & Co., LLC, KPMG, and Attain for an in-depth discussion of the CFI. Campus Strategies, LLC Page 2 of 2

3 CFI Instructions The accompanying set of worksheets will be used to calculate the CFI for your institution. Everyone should start with the adjustments page. It uses selected information from the financial statements to modify amounts reported in the financial statements. Several adjustments are necessary. First, private institutions following FASB reporting standards include net investment in plant as part of unrestricted net assets. These are not expendable net assets so they must be eliminated from unrestricted net assets. Note A on the adjustments page addresses this. For FASB institutions, temporarily restricted net assets may include resources that are to be used for plant or capital assets. For GASB institutions, restricted expendable net position may include resources that are to be used for capital assets. These amounts must be subtracted from expendable resources. Sometimes they will be disclosed on the face of the statements but, more likely, they will be found in the notes. Note B on the adjustments page addresses this. Not all private colleges and foundations present an operating measure in their statement of activities. If there is no indicated operating measure (e.g., net operating income/loss or net loss/surplus from operations or operating activities), the calculations must be based on the net change in unrestricted net assets and total unrestricted revenues. Note C on the adjustments page addresses this. If you're a private institution or a public institution following FASB standards, use the Financial Results (FASB) form Column A or B depending on whether an operating measure is presented. If you're a public institution use the Financial Results (GASB) form Column A for the institution and Column B for a GASB foundation. If the foundation follows FASB standards, use the Financial Results (FASB) form Column A or B depending on whether an operating measure is presented. FASB entities report all expenses as part of unrestricted net assets. Focus only on that section or column when completing the expense lines of the forms. When considering revenues, be sure to include net assets released from restrictions if they appear in the unrestricted net assets section or column. Campus Strategies, LLC Page 1 of 6

4 The net operating income or loss reported by a public institution does not represent the true picture of operating results. The financial reporting standards require the exclusion of various items that are used to support operations. These include state appropriations for operations, non-endowment gifts and contributions, nonoperating grants, and investment income. The worksheet includes extra lines for these items to provide a more accurate depiction of operating results. Note: Most of you will work only with your institution s balance sheet and activities statement to complete the calculations. However, you may need to look for a note that includes a table detailing the purposes of the temporarily restricted net assets or restricted expendable net position. That s where you ll find information necessary to complete the adjustment in note B. Campus Strategies, LLC Page 2 of 6

5 Data Locations FASB Institutions and Foundations NOTE: THE LABELS ON THE WORKSHEET MAY NOT MATCH THE TERMINOLOGY IN YOUR STATEMENTS. ASK IF YOU'RE UNSURE. Unrestricted net assets will be found near the bottom of the statement of financial position. Temporarily restricted net assets will be found near the bottom of the statement of financial position. If any temporarily restricted net assets are held for plant or capital purposes, this may be disclosed in the net assets section of the statement of financial position. If it does not appear there, look through the notes to the financial statements for a note addressing net assets and try to identify a dollar amount that is labeled restricted net assets for plant. It is possible that there are no restricted net assets of this type (or that the institution elected not to disclose them). Property, plant, and equipment will be found in the assets section of the statement of financial position. Plant-related debt will be found in the liabilities section of the statement of financial position. It usually will be labeled bonds or notes payable or longterm debt. Also look for capital leases, another form of plant-related debt. It is possible that the institution will divide the liabilities into two categories: current and noncurrent (or long-term). If this division is present, be sure to identify the amounts in both sections. Asset retirement obligations will be found in the liabilities section of the statement of financial position. Funds held in trust for plant purposes will be found in the assets section of the statement of financial position. Campus Strategies, LLC Page 3 of 6

6 Operating expenses or total expenses will be found on the statement of activities. Focus only on amounts reported in the unrestricted net assets column or section. Net operating loss/surplus will be found on the statement of activities. The net change in unrestricted net assets will be found near the bottom of the statement of activities. This amount is relevant only if the entity does not report an operating measure. Change in total net assets will be found near the bottom of the statement of activities. Be sure to check the column heading to ensure that you re picking up the amount for the correct year. Beginning total net assets will be found near the bottom of the statement of activities usually immediately above the ending total net assets. Be sure to check the column heading to ensure that you re picking up the amount for the correct year. Operating revenues will be found in the top section of the statement of activities. Total unrestricted revenues will be found in the top section of the statement of activities. This amount is relevant only if the entity does not report an operating measure. Campus Strategies, LLC Page 4 of 6

7 GASB Institutions and Foundations NOTE: THE LABELS ON THE WORKSHEET MAY NOT MATCH THE TERMINOLOGY IN YOUR STATEMENTS. ASK IF YOU'RE UNSURE. Unrestricted net position will be found near the bottom of the statement of net position. Restricted expendable net position will be found near the bottom of the statement of net position. If any restricted expendable net position is held for plant or capital purposes, this may be disclosed in the net position section of the statement of net position. If it does not appear there, look through the notes to the financial statements for a note addressing net position and try to identify a dollar amount that is labeled restricted net position for capital or plant purposes. It is possible that there are no restricted resources of this type (or that the institution elected not to disclose them). Funds held in trust for plant purposes will be found in the assets section of the statement of net position usually in noncurrent assets. Total operating expenses will be found on the statement of revenues, expenses, and changes in net position. Payments by the foundation to the institution will be found on the statement of revenues, expenses, and changes in net position (and may be included in the expense total). Interest expense will be found in the nonoperating revenues and expenses section near the bottom of the statement of revenues, expenses, and changes in net position. Other expenses, if applicable, will be found in the nonoperating revenues and expenses section near the bottom of the statement of revenues, expenses, and changes in net position. Note: Losses are never treated as expenses. Net operating loss will appear on the statement of revenues, expenses, and changes in net position. Campus Strategies, LLC Page 5 of 6

8 Plant debt and capital leases will be found in the liabilities section of the statement of net position. If there are amounts for these categories they likely will appear in both current and noncurrent liabilities. Change in total net position will be found near the bottom of the statement of revenues, expenses, and changes in net position. Be sure to check the column heading to ensure that you re picking up the amount for the correct year. Beginning total net position will be found near the bottom of the statement of revenues, expenses, and changes in net position usually immediately above the ending total net position. Be sure to check the column heading to ensure that you re picking up the amount for the correct year. Operating revenues will be found in the top section of the statement of revenues, expenses, and changes in net position. Government appropriations for operations will appear in the nonoperating revenues and expenses section of the statement of revenues, expenses, and changes in net position. Contributions or gifts (other than additions to endowment) will appear in the nonoperating revenues and expenses section of the statement of revenues, expenses, and changes in net position. Nonoperating grants (excluding capital grants) will appear in the nonoperating revenues and expenses section of the statement of revenues, expenses, and changes in net position. Sometimes this amount will be labeled federal or Pell grants. Net investment income used for operations will appear in the nonoperating revenues and expenses section of the statement of revenues, expenses, and changes in net position. Some institutions do not segregate this amount from net investment income. If this is the case, include the entire amount. Other nonoperating revenues, if applicable, will appear in the nonoperating revenues and expenses section of the statement of revenues, expenses, and changes in net position. It is unusual to see other nonoperating revenues. Ask if you are unsure whether to include amounts in this section. Campus Strategies, LLC Page 6 of 6

9 CFI SCORING SHEET FISCAL YEAR RATIO VALUE STRENGTH: Divide Value by These Factors WEIGHT: Multiply Strength by These Factors CFI SCORE--to one decimal place (Note 1) Primary Reserve--to three decimal places Viability--to three decimal places Return on Net Assets--percent to one decimal place Net Operating Revenues (or Net Unrestricted Revenues)--to one decimal place (Note 2) % 2.00% 0.2 % 0.7% (Note 3) 0.1 CFI SCORE - sum last column Note 1: Maximum score for the ratios is 3.5 for primary reserve and viability, 2 for return on net assets, and 1 for net operating revenues/net unrestricted revenues. If score exceeds these amounts, enter the maximum value in appropriate cell. Note 2: If no long-term debt is reported, the weights change as follows: viability ratio is ignored, primary reserve weight becomes.55, return on net assets weight becomes.30, net operating revenues/net unrestricted revenues weight becomes.15. Maximum scores become 5.5 for primary reserve, 3 for return on net assets, and 1.5 for net operating revenues/net unrestricted revenues. Note 3: Assumes use of operating measure; if change in unrestricted net assets is used, the strength factor is 1.3% versus 0.7%. Campus Strategies, LLC Page 5

University of Maine System and Component Units. Core Financial Ratios and Composite Financial Index. FY10 and FY11

University of Maine System and Component Units. Core Financial Ratios and Composite Financial Index. FY10 and FY11 University of Maine System Office of Finance and Treasurer January 2012 TABLE OF CONTENTS Page Introduction 1 Component Units 1 Primary Reserve Ratio 2 Net Operating Revenues Ratio 3 Return on Net Assets