RATIORATIO ANALYSISANALYSIS ININ HIGHERHIGHER EDUCATION:EDUCATION:

NEWNEW INSIGHTSINSIGHTS FORFOR LEADERSLEADERS OFOF PUBLICPUBLIC HIGHERHIGHER EDUCATIONEDUCATION

FIFTHFIFTH EDITION-PUBLICEDITION-PUBLIC INSTITUTIONSINSTITUTIONS © 2002 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association. All rights reserved. Printed in the U.S.A. I. IntroductionandAcknowledgements Standards Board(FASB) StatementofFinancial Accounting StandardsNos.116and117. implemented new standards causedby accountingandreporting theFinancial Accounting Sealy, LLC. The thirdedition,published in1995,dealtonly withprivate institutionsthat creditworthiness andrepresentedthebeginning ofthecollaborationwithPrager, McCarthy & The secondedition,published in1982,addeddebt-relatedratiosrelatingtoinstitutional statements. financial ratioanalysis asatooltobetterunderstandandinterpret used financial the 1970s,college have anduniversity parties seniormanagersandinterestedexternal trustees, framework andastrategic approachtomanagingdebt. stakeholders. To ratiomodeland aidtheirunderstanding,thispublication introducesafinancial resourceavailability,communicate financial needsandallocationdecisionstotheirvarious need toemploy analysis to enhancedcommunicationskillsanddifferent modelsforfinancial their traditionalroleandbecomeeven moreinvolved withstrategy, values andvision. They enable public managersmustcontinuetoexpand highereducationtoprosper. Seniorfinancial other issues. changes intechnology; andtheerosionoftraditionalgeographical boundaries,amongmany accountability,appropriations; increasingdemandsforgreater constant access andefficiency; contend withtheeffects ofaturbulentenvironment: fluctuationsingovernmental plant assets,theinstitution’s conditionandresultshave notchanged. fundamentalfinancial ispresentedandrequireinstitutionstodepreciatetheir information manner inwhich financial administrative bodies. changethe Although GASBStatementNos.34and35significantly managers, governing boards andotherstakeholders, includingfaculty, andlegislative and forsenior thatcreatesbothchallengesandopportunities reporting accounting andfinancial statements, alongwithseveral otherrelatedGASBstandards,representawatershed event in Governmental Accounting StandardsBoard(GASB)StatementNos.34and35. These Higher Education agencies usethemextensively. forprivate institutions. analystsin finance andcredit Trustees, seniormanagers,financial Many leadersinhighereducationview editionsasmilestonepublications thethirdandfourth ratiosinstrategic planning. includingtheuseoffinancial concepts tohighereducationfinance, ratioanalysis andintroducedseveral advanced financial new1999, significantly modelsand The fourth edition, The fourth editionof Since KPMGLLPintroducedthefirst These challengesmustbeaddressedby seniormanagersdifferently thaninthepastto leadersofhighereducationalsoneedto changeinreporting, Besides thissignificant edition, This fifth , isdesignedforpublic colleges, universities andrelatedentities thatadopt Ratio Analysis inHigherEducation:New Insightsfor Leaders ofPublic Measuring Past Performance toChartFuture Direction INTRODUCTION ANDACKNOWLEDGEMENTS Ratio Analysis inHigherEducation , published in in 1 RATIO ANALYSIS IN HIGHER EDUCATION 2 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION INTRODUCTION ANDACKNOWLEDGEMENTS achieve itsgoalsby: public highereducation. These principlesare: environmentprinciples andhave facing adjustedthemtoreflectthechallenging financial research, public service, medicalcareandtraining andemployableresearch, public service, skills training. missionsrelatingtoselectivity,to residentsofthatunit.Some institutionshave more specific (e.g., county, state) by providing accesstohighereducationandotherskillsatareasonable cost fundamental underlying thepeopleofsponsoringgovernment mission,thatis, toserve unit the mission;itisirrelevant otherwise. support affordability. metricstodetermine drive successandfinancial The strategic planshouldalways best activated by acomprehensive strategic plan. Well-managed institutionsusetheirmissionto stewards regarding what andwhy resourceswillbeusedtoaccomplishtheirvision.Missionis the extent towhich itisachieving thatmission.Missioninspiresandguidesinstitutional alongtheway andnon-financial, tohelptheinstitutionunderstand measurement, bothfinancial believe thatevery institutionshouldhave aclearly missionandthattheremustbe articulated While many public institutions donothave comprehensive strategic plans,alldohave a The basisforeffective applicationofratio analysis isaclearinstitutionalmission. We Explaining relative liquidity, viability, financial andleverage attributes. totheinstitutionand concern anomaliesandfocusingattentiononmattersthatshouldbeof Identifying financial andfunctionaleffectiveness,Gauging institutionalperformance for creditworthiness, Assessing theinstitution’s abilitytorepay andfuturedebt,includingitsrationale current Quantifying thestatus,sources,andusesofresources, againstinstitutionalstrategicMeasuring successfactors objectives, We institutions. F Use readily available and information Present afew key ratiostoanswer thesequestions, F mission, Use ratiostomeasuretheacquisitionanduseofresourcesachieve theinstitution’s Several principlesguidedtheearliereditionsof ocus ontrendsininstitutionalratiosandestablish benchmarkcomparisonswithsimilar toaddress key information questionsraisedbyocus onsummary stakeholders,

believe that financial ratioanalysisbelieve canplay roleinhelpingeachinstitution anintegral thatfinancial Ratio Analysis . We have reexamined these as achieving mission. These include: there areseveral commonattributesofsuccessful public institutionswhere successisdefined stakeholders. public colleges anduniversities totheinstitutions’ andcommunicatingthisinformation in thedevelopment ofanew conceptualframework of information foranalyzing thefinancial statements. message andthemeaningofpublicly haveThese factors financial reported resulted andmeasurementmethodswill changeboththe reporting alteredfinancial significantly standardshave reporting statementtransactions.Neworganizations financial andoff-financial governmental appropriations andhave led, insomecases,toincreaseduseofaffiliated the needtoidentify, enhanceandmanageothersourcesofrevenue besidestuitionand goalsandobjectives have areofteninconflict.Budgetuncertainties resultedin Stakeholders’ university? Why changethewayweanalyzefinancialhealthofapubliccollegeor themselves: We outitsmission. tocarry provide profile theinstitutionwithtoolstoimprove itsfinancial sponsoring government. ov goals andobjectives ofindividual withthe entitieswithinastatesystemmay notbecongruent to thevariability ofgovernmental fundingandconflictingstakeholder goals.Inaddition,the senior management.Generally, iscausedby thefailure aconfluenceofnegative related factors plansintotheinstitution’sand financial strategic oftheinstitution’s planisoftennotthefault operating ordepartments’ help themachieve theirvarious theirmission,ortointegrate schools’ erall visionofthesystem’s administration,orofthelegislative andexecutive branchesofthe

believe questionsthatpublic institutions needtoask therearefourkey financial In working withpublic highereducationover many decades,we have that determined Public highereducationhasundergone andwillcontinuetoundergo dramaticchanges. This publication describesfourstrategic ratiosthathelpanswer thesequestions. Is debtmanagedstrategically toadvance the mission? Do operatingresultsindicatetheinstitutionisliving withinavailable resources? thestrategic direction? support assetperformance Does financial andflexible themission? enoughtosupport Are resourcessufficient objectives and Ratio analysis againstinstitution-specific canmeasuresuccessfactors ofmanyThe failure public institutionstoadoptmeaningfulandconcisestrategic plansto F W Effective seniorleadership, inancial resourcesinvested properly, ell-defined missionthatisexecuted andmeasuredagainstclearly objectives,ell-defined articulated INTRODUCTION ANDACKNOWLEDGEMENTS 3 RATIO ANALYSIS IN HIGHER EDUCATION 4 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION INTRODUCTION ANDACKNOWLEDGEMENTS concepts to chart futuredirection. concepts tochart standards. We alsoplanonworking aswe withourcolleagues intheindustry usethese of additionalratiosandmodelsaspublic institutionsadoptthenew accountingandreporting industry. We lookforward totheongoingevolution oftheseratiosandmodelsdevelopment Vi P UniversityKitterman, ofIdaho;DonaldZekan,University Roger ofMassachusetts,Dartmouth; NA Community Colleges; SusanFitzgerald, Moody’s Goldstein, Investor Larry Services; (formerly atUniversity ofMissouri); RufusGlasperandJeffrey West, The Maricopa analysts: Pamela Clayton, JimMcGill, Fitch RatingsService; The JohnsHopkinsUniversity acknowledged leaders of public colleges anduniversities, associationsandfinancial industry Thomas, aswell Phil asretiredpartner Tahey. T from Prager, McCarthy &Sealy, LLC;andfromKPMG,theHigherEducationLeadership includingJoeBeare,SaulRosenbaumandBrianSandquist National HigherEducationgroup Fred PragerandChrisCowenprofessionals frombothfirms: andtheotherprofessionalsin tohighereducation. services providerThe projectwas ledby offinancial ateamofsenior education: KPMGLLP, andPrager, McCarthy &Sealy, theassuranceandtaxfirm, LLC, thebusinessofhigher dedicatedtoserving represents thecontinuingcollaborationoftwo firms Acknowledgements governance tax-exempt structure, statusorotherattributes. found thatthekey questionsasked above apply toallinstitutions,regardless oftheirmission, itself. Through ourwork withinstitutionsofhighereducation,bothpublic andprivate, we have universities, academicmedicalcenters,individual institutions withinasystemand all typesofpublic institutionsincludingcommunitycolleges, researchinstitutions,landgrant eam ofJohnKeenan, RichMcKinless,LouMezzina, Terry StanlisandMark Simon,Ingrid atterson, University CarolinaatChapelHill; ofNorth Yoke SanReynolds, University of r ginia; andMatthew Filipic, Wright StateUniversity. CUBO SeniorFellow; Judyvan Gorden,University andKyle ofColorado;Ken Harris We We Ratio Analysis inHigherEducation:New Insightsfor Leaders ofPublic Higher Education We The attributeslistedabove andtheframework inthispublication setforth areapplicable to effectivelyInformation communicatedtostakeholders. Debt usedstrategically and Holistic approachinplanning,managementandmeasurement,

received valuable commentsandadvicefromthefollowing experienced and have enjoyed toprovide theopportunity theseconceptstothehighereducation will focus our discussion on the financial aspectsoftheseattributesinthispublication. will focusourdiscussiononthefinancial Robinson in developing the basic ideas for the first threeeditions. Robinson indeveloping thebasicideasforfirst editionof contained inthefourth & Public Sectorlineofbusiness,andmarketing Newman. director, Merry toJackMiller,Special thanksforcontinuingsupport Vice ofKPMG’s Chairman HealthCare v ersions ofthispublication: JohnMoriarty, SeanKeenan, Terry MenzelandMandyNelson. We We

also acknowledge thecontributionsofRonSalluzzowho developed thebasicconcepts w ould like tothankthefollowing who alsocommentedondraft KPMGLLPpartners Ratio Analysis inHigherEducation INTRODUCTION ANDACKNOWLEDGEMENTS and Fred Turk andDan 5 RATIO ANALYSIS IN HIGHER EDUCATION

II. PressuresandChallengesAffectingLeadersofPublicHigherEducation Stakeholders have varying ofinfluence,andoftenconflictinggoalssuchas: degrees government andarequickly affected by theoutcomeofelectionsinthosebranches. Governing boardsaremoreaccountable totheexecutive andlegislative branches of local residents,studentsandgovernmentadministrators, grantors, executives, amongothers. f actandreactdifferently to threatsandchallenges. counterparts, These stakeholders include Stakeholders standards. communicating changingreporting from legislative bodies,allocatinglimitedresources andadaptingtoeffectively uncertainties stakeholder interests,respondingto increasedcompetition,managingfinancial CFOsarebalancing challengesfacing skills andmethods.Someofthemoresignificant successful atpublic institutions inthe21stcentury, they mustadaptandadoptnew mission andmajorinvestments ininstitutionalinnovation andgrowth.” For CFOstobe focus onstrategic productsasinstitutionalvalues andvisionforthefuture,institutional expanders whoboundary gowell beyond merely managingandcontrolling operations;they Morley andDougEadiein communicationsofficer. also thechieffinancial decisions tostakeholders. Inotherwords, but theCFOisnotonly thechiefbusinessofficer year; andtocommunicatethese funding issuddenly frozenordecreasedduringthefiscal needs withavailable resourceallocationdecisionswhen legislative funds;tomake difficult other executive branchdepartments. The CFOisfrequently calledupontobalanceresource Often, theCFOisliaisonwithlegislative budgetcommittees,systemadministrationand ov (CFO),isalsothechiefadministrative withresponsibilities officer officer the chieffinancial and itsseniormanagerstochange,adaptadoptnew methodstoprosper. accountability. totheinstitution These pressuresandotherchallengesalsopresentopportunities f skills,limited consumers, continuouscomplaintsby employers over students’ lackofgraduated challenges:risingcosts,value-shoppingcommunity colleges—are extraordinary facing by aculty, staff andemployees, alumni,legislative bodies,governing boards, system inancial flexibility and elected officials questioning spendinganddemandinggreater inancial flexibility andelectedofficials er human resources, facilities, information technology, information er humanresources,facilities, andsecurity. enterprises auxiliary Public institutions,withmoreanddiverse stakeholders thantheirprivate CFOs needtobecomemorefocusedonleadingratherthanmanaging. According toJay In many toin thispublication public as institutions,theseniorbusinessofficer, referred Public institutionsatalllevels—state systems,individual colleges anduniversities, and Efficiency vs.local employmentEfficiency andeconomicdevelopment. Affordability orreductionsand vs.appropriation uncertainties Access vs.qualityofstudentsandnationalrankings, PRESSURES AND CHALLENGES AFFECTING LEADERS OFPUBLICHIGHEREDUCATION The Extraordinary HigherEducationLeader, “ leadersare 7 RATIO ANALYSIS IN HIGHER EDUCATION 8 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION PRESSURES AND CHALLENGES AFFECTING IZALLEADERS OFPUBLICHIGHEREDUCATION projects deemedalower priorityby institutions. andinvestment, fundingfortransformation adequate andstable long-term orrestrictfundingto within theirsystemwiththegoalofimproving educationyet legislatures toprovide fail flexibility toattainthem.Stateboardsofeducationencouragecompetition funding orfinancial public institutionsandmandateaccessoraffordability goalswithoutproviding sufficient capital plansorinstitutemid-year budgetfreezes.Legislatures demandmoreaccountabilityby among states.Suddeneconomicdownturns causemany statestoreduce subsidies,suspend governmental revenues and theoverall economicenvironment, andcandiffer considerably fluctuatedramatically duetochangesin Appropriations foroperatingandcapitalpurposes yet decreasingpercentageofoperatingfundsandcapitalfunds. bodies forasignificant, Financial Pressures From Legislative Bodies analysis). orresponsibilitycenter monitoring(suchasprofit andfinancial faculty attracting highprofile research investment aid, sector, andtechnology targeting transferwith thefor-profit financial increasingly becominginvolved infund-raising(development), active studentrecruitment, that historically centersforpublic have institutionsthatfundedotherprograms. beenprofit offering market-driven coursesatlow coststoadultandcontinuingeducationmarkets –areas compete witheachotherforsimilarstudentsandscarceresources.For-profit entitiesare f to attainhigherrankingsinnationalsurveys. Stateboardsofhighereducationhave generally and attractdifferent typesofstudents. There isoftenaddedpressuretoincreasestudentquality and addstudentshascausedprivate andpublic institutionstoexpand theirbasesofoperations removed traditionalgeographic boundariesviadistancelearning. The needtogrow revenues state public institutionsandeven institutionswithinthesamesystem. Technology hasgenerally otherin-statepublic institutions,out-of- including private corporations, institutions,for-profit Competition government. have andlevels aplanareatthemercy ofchangingfundingpatterns by thesponsoring communicate effectively becausethey donothave acoherentstrategic plan.Othersthatdo stakeholders, hopingthattheirinfluencewillwane over time.Someinstitutionsareunable to Other institutionshave adopteda“leave mealone”strategy andnotactively engagedtheir with theirstakeholders andeffectively albeitpositive communicateinformation, ornegative. with themeffectively hasbeenuneven. Successfulinstitutionshave developed plans long-term ailed tomonitorindividual institution’s missionsandexpansion, causingsisterinstitutions to Public institutions,unlike private institutions,have toeffectively interactwithlegislative Many public institutionshave respondedby becomingmorelike private institutions, Public institutionsareunderever-increasing pressurefromamultitudeofentities needsandcommunicate The responseby public institutionstobalancetheirstakeholders’ demanding more transparency in financial statementsandthesechangeswill providedemanding moretransparency amore in financial themselves in anew andtotally different mannerandnotfocusonthechange itself.Usersare institution’s statements. financial require theinstitution’s inthe tobereported otheraffiliates foundationsandcertain affiliated e measure; andpresentationofgovernmental appropriations,investment incomeandinterest depreciation ofallplantassets;introductionacashflow statement; useofanoperating recognitionconsolidated totalsinsteadoffundgroups; ofadditionalplantassetsand statementswithnetassetsreplacingfundbalances; financial ofpublic institutions’ the format changes to conditions.GASBStatementNos.34and35willcausesignificant meeting certain at leastinitially. GASBStatementNo.33requirespublic institutionstorecognize pledges f Changes toFinancialReportingStandards abundanceordifficulty. ofmission,eitherinperiodsfinancial fulfillment developed growth andimplementedstrategic plansthatpermit inareasofexcellence and andeliminatedunneededprograms. Manyamong departments public institutionshave not travel.solutions like curtailing A numberofpublic institutionshave setprioritiesforfunding practices suchasinstitutingbudgetfreezes,acrosstheboardreductionsorothershort-term operate andincreasedcompetitionforproven faculty. operate duetoextensive andequipment,administrative capitalneedsforfacilities to support oreliminated.Researchprograms areincreasinglyand arenotcurtailed expensive togrow and viable continue priorities. Long-timeprograms thatarenotrelatedtomissionorfinancially maintenancefundingislargely anddeferred dependentonchanginglegislativeupgrading g with many and forundergraduate institutionsplacingahigherpriorityoninstitutionalgrants competitiveness. Financial aidandtuitiondiscountingtechniquesaremorecommonly used, mustbeincreasedtomaintain tomeasure.Salariesandbenefits thatisdifficult return technologyInformation expenditures ofoperatingbudgetswitha consumealarger portion resources.Studentsaredemandingandreceiving moreamenities. decreasing poolsoffinancial Limited Resources to Allocate have proliferatedasanalternative totraditionalcapitalappropriations ordebtissuances. such asjointventures withrealestatedevelopers andoperatestudenthousing, toconstruct endowment statementtransactions, funds,toattainmorestable sourcesoffunds.Off-financial inancial statements and will also increase the difficulty of preparing long-term trendanalysis, ofpreparinglong-term inancial statementsandwillalsoincreasethedifficulty xpense as nonoperating items. GASB Statement No. 39 on affiliated organizations will xpense asnonoperatingitems.GASBStatementNo.39on affiliated raduate students demonstrating need. Infrastructure continuestoageanddeterioratewhileraduate studentsdemonstratingneed.Infrastructure Public institutionsshouldrespondby takingadvantage topresent oftheopportunity standardswillcauseconfusiontomanyChanges toaccountingandreporting usersof Public institutionshave tendedtorespondthesechallengesby continuingtraditional Institutional stakeholders continuetoincreasetheirdemandsonlimitedandsometimes Public institutionshave suchas reserves, respondedby increasingtheirfinancial PRESSURES AND CHALLENGES AFFECTING LEADERS OFPUBLICHIGHEREDUCATION 9 RATIO ANALYSIS IN HIGHER EDUCATION 10 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION PRESSURES AND CHALLENGES AFFECTING LEADERS OFPUBLICHIGHEREDUCATION f theinstitution’sarticulate message. This publication andourongoingwork withmeasuresof communication toolstohelpthemengagetheirstakeholders regarding thesedecisionsand manage debtissuanceseffectively andfairly amongtheoperatingunits. And they need allocate resourcesinternally, and assignprioritiesforfunding,dealwithcapitalstructure and amountneeded, andwhere they shouldbeused. They needaframework andtoolsto institution’s strategic plan. acoherentmessageaboutresources,thetype They needtoarticulate budgetcycle, contributionstothe andmake important to longertimehorizonsthanthecurrent resourcesandneeds. performance, about financial Using alarge numberofratiosobscurestheabilitytodeliver acoherent andconcisemessage of revenues andexpenditures haslimitedusein today’s competitive fast-paced environment. historicaltrendanalysisand adoptnew long-term methodsandcommunicationtools.Internal, f Conclusion presentation. f in researchfunding.For theinstitutiontoimprove some,thesechangespermit uponitscurrent communicated throughdisplay ordisclosure,suchasresultsofacapitalcampaignincreases transactionsorevents.highlighting trendsandotherimportant Othermessagescanbe statementsinanarrative form, analysis toexplain thefinancial sectionpresentsanopportunity presentedorreleased. consistent withotherinformation The management’s discussionand tostakeholders sothatitisunderstoodand how information tocommunicatekey financial governing board, president,otherseniormanagersandpublic affairs personneltodetermine shouldwork pictureoftheentireinstitution. Finance officers withthe complete financial inancial performance areaimedathelpingmeetthesechallenges. inancial performance analysis needtodiscard“old-time”financial inancial resourcesandneeds,businessofficers inancial disclosureswhile otherswillneeddramaticrevisions totheirapproachand F To inance officers needtobeable tocontinuethinkmorestrategically,inance officers expand theirvision

respond tothesechallengesandeffectively communicatewithstakeholders about III. RationaleforDevelopingaNewFrameworkFinancialAnalysis and opportunities forimprovement.and opportunities progress inaligningresourceswithinstitutionalgoalsandhelpthemidentifytheirsuccesses This holisticapproachcanhelptheleadersofinstitution andotherkey constituentsassess considered whether ornotthey areordinarily includedintheinstitution’s statements. financial etc.,shouldbe subsidiaries,partnerships, mission, theinstitution,includingaffiliates, Strategic View oftheInstitution -Holistic Approach competitiveness oftheinstitution. growthsupport inmission-criticalareaswhich,canincreasetheoverall inturn, f toeachinstitution, outtheirmission.Besidesthereasonsthatwillbespecific carrying resourcesiscriticalto stakeholders why accumulating,maintainingandusingfinancial to resources,thereisagrowing –toarticulate need–andanopportunity indirect financial achievement over isnotattainable. thelongterm thatcontinued and find inthenearterm achieve difficulty theirmissionwithoutgreat resourcesmay beunable to operating andcapitalneeds.Institutionswithoutsuchfinancial fund program initiatives, fundingstabilityfor provide long-term greater studentaidandpermit outthemission.Financialto deploy resources(expendable canbeused to incarrying reserves) Measures FinancialResources stakeholders. Eachoftheseattributesisdescribedmorefully below. analysis ofpublic institutionsshould: analysis ofpublicmissions, anew institutionsisneeded.Financial approachtofinancial inancial resources, in general, can help cushion against unexpected budgetary pressuresand inancial resources,ingeneral,canhelpcushionagainstunexpected budgetary When evaluating the financial performance of an institution in terms ofachieving ofaninstitutioninterms its performance When evaluating thefinancial While inthepast,public institutionsmay have beenreluctanttodisclosetheirdirectand resources A key attributeofasuccessfulpublic institutionistheaccumulationoffinancial In addition,thesemeasuresmustbesimpletocalculateandeasycommunicate ofprograms tomission. Measure importance Measure useofresourcestoachieve missionand Measure leverage, Vi resources, Measure financial F or leadersofpublic institutionstobesuccessfulandhelptheirachieve their ew

the institutionholistically, RATIONALE FORDEVELOPING A NEWFRAMEWORK FORFINANCIAL ANALYSIS 11 RATIO ANALYSIS IN HIGHER EDUCATION 12 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION RATIONALE FORDEVELOPING A NEWFRAMEWORK FORFINANCIAL ANALYSIS wa F accordingto onaGASB-basiswiththosereported combining netassetsthatarereported out itsmission,especially inlessfavorable economicenvironments. as astrategic goal,itsinfluenceonthecostofcapitalmay affect theinstitution’s abilitytocarry e theirdebtcapacity.in determining They want tounderstandtheinstitution’s overall debt lower levels. measures shouldbeattheinstitution-widelevel withtheabilityformoredetailedanalysis at balance onmakingtheseinvestments toinvest andretainingreserves inthefuture. The invested inhuman,technological orphysical capitalassets.Institutionsshouldstrive fora many resourcesmay beasignofnotachieving missionasfundsareaccumulated andnot institution usesitsresourcestoachieve mission needstobemeasuredandcommunicated. Too Measures UseofFinancialResources more debtfrequently andrely moreonprivate giftstoreplacecapitalappropriations. successofpublic institutions.Itislikelyterm thatpublic institutionsinthefuturewillissue However, analysis willbecomemorecriticaltothelong- of,andchangesto,capitalstructures institutions alsooftenhave controlover greater andtimingofdebtissued. thenature,terms individual institutionstosystemapproval tolegislative approval tovoter approval. Private allocated tothesystemorindividual institution. Authority toissuedebtalsovaries from and recognition models.Debtissuedby astateagency may inthatagency, bereported statements,public institutionshave financial different authority is reflectedintheinstitutions’ Unlike private agency institutionsthathave that theauthoritytoissuedebtthroughafinancing institutions thatrely moreupontuition,debtandprivate giftstofundtheircapitalneeds. ofdebtissuances. amount, timing,typeandpurpose need tobemonitoredcontinuously. A framework the shouldbeestablished todetermine and physical plant.Debt,usedwisely, can assist inachieving mission.Debtlevels andcapacity ofaninstitution’s part Debtisapermanent incurred. like endowment capitalstructure funds Measures Leverage isenhancedbyperformance combiningthem. xposure as part oftheiranalysis.xposure aspart And, while we creditrating donotview achieving aspecific ASB. However, thedifferences between to thetwo basesofaccountingarenotthatsignificant r rant exclusion while the measurement of financial resources, leveragerant exclusion andoperating while themeasurementoffinancial We In addition,ratingagenciesandinvestment bankers oftenconsiderinstitutionsholistically Accumulation of financial resourcesshouldnotbeanendinitself.Rather, howAccumulation offinancial an Public institutionsgenerally rely moreoncapitalappropriationscomparedtoprivate analysis mustmeasureleverageThe financial orindebtednessthattheinstitutionhas

also recognize thiskindofholistic strategic assessmentmay thatperforming require decreased. where allocationofresourcesshouldbeincreasedor help seniormanagersdetermine should beflexible totheuniquenatureofinstitutionandshould andadaptable toconform should beevaluated tomission.Measuresemployed againstcriteriaregarding theirimportance resources arediffused andinstitutionalclarityisdecreased.Periodically, programs orunits mission. Programs have tobealignedwithinstitutionalobjectives andgoals,otherwise Measures Importance ofPrograms to Mission The financial analysis ofindividual mustbeable tomeasuretheimportance programs to The financial RATIONALE FORDEVELOPING A NEWFRAMEWORK FORFINANCIAL ANALYSIS 13 RATIO ANALYSIS IN HIGHER EDUCATION

IV. ANewFrameworkforFinancialAnalysisofPublicInstitutions transformation on the institution, and serves asagateway ontheinstitution,andserves transformation tothefourotherhigh-level questions. mission; itisirrelevant otherwise. and strategic planandassessed periodically. Well-managed institutions usemissiontodrive success accomplishing itsmission. Whatever measuresarechosen,they shouldbemaintainedina f circle. Missionisbestactivated throughastrategic plan. A few high-level measures— represented by theouter ringofquestions,shouldbedriven by mission,shown intheinner will beusedtoaccomplishtheirvision. alldecisionsmadebyshould inform institutionalstewards regarding what andwhy resources education, then, the most important questionis, education, then,themostimportant of thesequestions. A discussionofeachquestionfollows. should askanumberofhigh-orderquestions. The schematicbelow depictstheinterrelationship andoperationalsuccess ofaninstitution,leadersandinterestedobservers measure thefinancial e inancial and non-financial —areessentialtounderstandtheinstitution’sinancial andnon-financial in performance xternal pressuresandtopositionthemselves forsuccessinthe21stcentury.xternal To analyze and f Measuring overall financial health is an essential first stepwhen assessing theimpactof healthisanessentialfirst Measuring overall financial The precedingschematicemphasizestheconceptthatallresourcedecisions,as Central to all questions about change and transformation ismission.IntheworldCentral toallquestionsaboutchangeandtransformation ofhigher Most colleges anduniversities themselves tocopewithsignificant aretransforming inancial metrics strategically the mission? toadvance managed Is debt to determine affordability.to determine The strategic planshouldalways the support A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS What istheoverallleveloffinancialhealth? Do operatingresultsindicatetheinstitution Are resourcessufficientandflexible What istheinstitution’s mission? is livingwithinavailableresources? enough tosupportthemission? What istheinstitution’s mission? performance support the direction? strategic financial asset Does Mission 15 RATIO ANALYSIS IN HIGHER EDUCATION 16 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS therefore, bewary ofdiversions thatsubvert progress toward achieving themission. its resourceinflow streams isessentialtoachieving theinstitution’s mission.Stewards must, future oftheinstitutiondependsonitsabilitytoreplaceand enhanceitscapitalbase,managing governmentand grantors, agencies, investors, andratingagencies.Becausethelong-term includingparents,accreditingbodies, donors parties, institutions andisanissueforexternal Does financialassetperformancesupportthestrategicdirection? analysisfurther andaction. process. transformation flexibility willhelpstewards institutionalrisktoleranceinthe determine parties andexternal will dependupontheinstitution’s base.Understandingthis andfinancial performance fiscal f Are resourcessufficientandflexibleenoughtosupportthemission? toachieving institutionalgoals. will createabarrier resources doesnotguaranteethey willbeinvested strategically. However, resources insufficient andtheexistence of because issuescriticaltoinstitutionalmissionareoftennon-financial, Adequate capacitytocreateresourceswillnotensuresuccessfulcompletionofmission outitsintendedprograms. capacitytocarry continuing financial f What istheoverallleveloffinancialhealth? rather than spread insufficient resources overrather thanspreadinsufficient many programs. the years aheadasinstitutionsdirectresources toselectedprograms thatenhancetheirsuccess, improve while lowering services academicandsupport costs. These activities willacceleratein mission. Many colleges self-examination anduniversities to areundergoing significant Do operatingresultsindicatetheinstitutionislivingwithin availableresources? inancial resources.Flexibility inmakingdecisionsaboutfutureinstitutionaltransformation programs, andsecond, outitscurrent inancial capacitytosuccessfully theinstitution’s carry The long-term financing of an institution is a daunting challenge facing leadersofpublic ofaninstitutionisadauntingchallengefacing financing The long-term A simpleanddirectanswer toeachofthesequestionsprovides for baselineinformation beginning, ornot? year thanitwas betteroff atthe attheendoffiscal Is theinstitutionfinancially healthyIs theinstitutionclearly asofthebalancesheetdate,ornot? financially Tw withhelpingpolicymakersThis questionisconcerned assessthestatusofinstitution’s The institution’s answer tothisquestioniscriticalifitwishesthrive inthe21stcentury. theinstitution’sThis questionfocusesattentionontwo health:first, levels offinancial The allocationofscarceresourcesisacriticalfunctionleaders inachieving institutional o related questions address financial sufficiency andresultingflexibility: sufficiency o relatedquestionsaddressfinancial The policy shouldachieve thefollowing objectives: debt policy, thispolicy tothestakeholders articulates andperiodically measuresattainment. andprogrammatically ifitdevelopsAn institutionwillbestrongerfinancially anappropriate presented canhelpsettargets forevaluating andmanagingtheamountofdebtataninstitution. debtpolicy.institution —andnotthecredit-ratingagencies—shoulddetermine The ratios of debttoachieve strategic goals.Sincemanagement isbestable toevaluate itsneeds,the debtpolicy providesformal theframework throughwhich theinstitutioncanevaluate theuse such, adebtpolicy shouldbelinked tothemissionandstrategic objectives oftheinstitution. A Is debtmanagedstrategicallytoadvancethemission? to allocatescarceresourceseffectively across thesecompetingpriorities. advantages. A conceptualmodelisintroducedlaterthatprovides institutionswithamechanism mission, prioritizeprojectsmethodically andappropriately buildsustainable competitive represents bothanincreasedthreatandopportunity. channels,competitionfrombothtraditionalandnontraditionalorganizations learning toentry.students createdanaturalbarrier With thegrowth oftechnology anduseofdistance advantage ofaninstitution’s perceived orrealweaknesses, sincegeography andaccessto the competition.Historically, itwas notpossible formany otherorganizations totake management timeandinstitutionalfocus. Weak for areasinaninstitutionpresentopportunities stave off competition. improve thatadvantage, distinguishitselfinternally aswell astothepotential student,and advantage, andthenstrengtheningprograms withinthoseareas,theinstitutionwillbeable to a limitednumberofareasinwhich theinstitutionhasordesirestohave acompetitive other activities representcore,mission-relatedactivities andthosethatdonot.Bydetermining investments. Itis,therefore,criticaltoidentifywhich and programs, researchopportunities area inwhich itchoosestoparticipate. This willrequiretargeted andincreasingly larger resources retained, inevery becausethesuccessfulorganization mustbeasuperiorperformer Debt isatoolusedtoachieve strategies oftheinstitution,andas thedesiredlong-term investmentsStrengthening coreprograms andmakingnecessary focusactivities onthe Continuing toinvest innon-coreactivities absorbslimitedresources,includingmoney, There isnoorganization thatcansucceedinallareas,regardless oftheamount respond toany changesinthemarket. regularly toensurethattheinstitution iscontinuingtomeetitsstrategic objectives andto Second, thepolicy shouldestablish onandreevaluated broadguidelinesthatare reported entities.) foundationsorspecialpurpose issued by affiliated additional transactionsthatimpacttheinstitution’s creditanddebtcapacitysuchas debt (Thisincludesnotonlyportfolio. directobligations issuedby theinstitution, but any F irst, itshouldprovide managementwithcontrolover theinstitution’s entiredebt A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS 17 RATIO ANALYSIS IN HIGHER EDUCATION 18 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS Linking DebtPolicytotheMission against stated long-term objectives.against statedlong-term not theabsolutelevel ofresourcesthatdictatessufficiency, butthedeployment ofresources f achieve tolinktheirresourcescoremissionwill success.Institutionsthatfail long-term their missionanddeploy resourcestoachieve mission-guidedresultswill be positionedto institution andresourcesmustbedeployed strategically. Institutionsthatremainfocusedon viewed ofaprocessandnotasindividual aspart transactions. the capitalizationofinstitution,similartoendowment debtshouldbe funds.Furthermore, operating environment. Increatingadebtpolicy, of portion thefocusisondebtasaperpetual ultimately, totheinstitutionalmission. Without tocreateacohesive thislinkage,itisdifficult ind it difficult tosustainacompetitiveind itdifficult advantage indeterioratingmarkets. Interestingly, itis It should be noted that achievement or maintenance of a specific bondratingshouldnotbe It shouldbenotedthatachievement ormaintenanceofaspecific a goalofthepolicy. f theinstitutiontocontinueissuedebtand rating fortheinstitutionthatwillpermit F strategic objectives. institution’s capitalneedsandachieve thelowest overall costofcapitalconsistentwith Third, thepolicy shouldhave theobjective ofproviding the additionalfundstosupport To F inance capitalprojectsatfavorable interestrates. ollowing isaschematicthatdemonstrateshow debtpolicy linkstothestrategic planand, inally, thepolicy shouldencouragethemaintenanceofhighestacceptable credit

realize institutionalgoals,themissionmustbeclearly throughoutthe articulated Debt Capacity Institutional Mission Strategic Plan Debt Policy Financial Transactions affiliated special purpose entities, it may be difficult to obtain financial information aboutall information entities,itmaytoobtainfinancial special purpose bedifficult affiliated nature oftherelationshipsbetween foundationsandother theinstitution anditsaffiliated and/oroperateinstitution-relatedassets suchasstudenthousing.Duetothe used toconstruct entities foundations usedforfund-raising, researchorrealestateandotherspecialpurpose performance. This willincludetheinstitutionitself,itsaffiliated resources, debtandfinancial f discussed. Sincepublic institutionshave different operatingcharacteristics,other significantly different ratiosfortheir analysis andprovide additionalinsightintothequestionspreviously may choose Otherleadersinhighereducationfinance mission andassessperformance. a morecompletemeasureofinstitutionalstrength. tounderstand satisfaction andstudentfaculty other areassuchasacademics,infrastructure f healthoftheinstitution.Notethattheseratiosdealonly withthe onthefinancial information isobtainable andthecalculationsrepeatable.information These fourratiosprovide powerful effectively health;andsecond, provide thattheratiosaremostusefulif insighttofinancial performance. indicator ofoverall financial oftotalresources, isakey operatingsizeandinterms achieve, ofcurrent bothinterms resources. context thattheinstitutionhasbeenable ofuseable, to The return retainedfinancial net assetsprovide insightintowhether theinstitution’s operatingsizeisreasonable inthe understanding oftheinstitution’s andtheaffordability capitalstructure ofitsdebt.Expendable resources,therelative debtlevelretained financial becomesinformative, allowing an debt, by itself,isnotaparticularly informative number. Butwithinthecontext ofuseable relation toinstitutionalriskthatmustbeconsistently addressed. As anexample, outstanding Operating Revenues Ratio resources ( resources. They measuretheabilityofinstitutiontogenerateoverall againstallnet return obligations ( and itsoutstandinglong-term healthoftheinstitution. the overall financial historically andinthefuture,willbemostinformative inhelpinganswer thequestionabout institution. We thinkthatfourstrategic ratios,when consideredtogether andover time desirable tohelpprovide aclear, highlevel healthofthe assessmentoftheoverall financial Description ofStrategicRatios inancial ratiosmay beemployed healthandmanagementperformance. toevaluate financial inancial aspectsoftheinstitutionandmustbeblended withkey indicatorsin performance As statedabove, tomeasure thepublic institution’s itisimportant entirefinancial We Tw These ratioswere selectedbecausethey representmeasurementofkey componentsin These ratioscomparetheinstitution’s operatingcommitments( As previously discussed, we believe thatalimitednumberofinformative ratiosare o basicconceptsareemphasizedinthisanalysis: First, thatafew measurescan

believe thateveryone inan institutionshouldhave key metrics todrive performance Return onNet Assets Ratio A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS ). ) and on a short-term basistolive withinitsmeans( ) andonashort-term Vi a bility Ratio ) againstitsexpendable financial Primary ReserveRatio Net ) 19 RATIO ANALYSIS IN HIGHER EDUCATION 20 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS size sincethey aretypically management control. less volatile and undergreater reported asnetassets. reported asliabilitiesshouldbeadjustedsothatthesefundsare of theinstitutionthatarereported fundraising foundationsfollowing FASB practices,thefoundation’s fundsheldforthebenefit that may beneededisgenerally inthenotes.Inevaluating reported thenetassetsofaffiliated e ineithertheGASBstatementofrevenues,changes innetassetsandexpenses isreported invested about ortobeinvested entities.Information inplant,areusedfortheaffiliated for theinstitution.FASB unrestrictedandtemporarily restrictednetassets,excluding those restricted expendable netassets,excluding thoseinvested ortobeinvested inplant,areused notes. positionorbalancesheet (FASB(GASB basis)andstatementoffinancial basis)orinthe netassetsanddebtisgenerally ofthestatementnetassets concerning containedontheface orstatementsarenotpresentedwiththeinstitution’sinformation statements.Information iftheaffiliate statementsoftheaffiliates, statements oftheinstitutionorseparatefinancial analysis beingmisleadingorincomplete. e entities, ofdebtin somecases,residesintheaffiliated portion cases, aswell asasignificant entities. Inaddition,sincethemajorityofapublic institution’s resourcesinmany financial exclusion enoughtowarrant oftheaffiliated 35 by public institutionsandarenotsignificant F entities willfollow FASB practices.Even thoughtherearedifferences between theGASBand issued by boththeGASBandFASB. Generally, foundationsandspecialpurpose affiliated may toincludeintheanalysis.incomplete ormisleading.Immaterialaffiliates notbenecessary sothatexclusion doesnotresultintheanalysis isnecessary information beingmaterially financial entities’ which Materialityshouldbeconsidered indetermining affiliated affiliates. gr analysis indicateswhether aninstitution hasincreaseditsnetworth totherateof inproportion its expendable withoutrelying reserves onadditionalnetassetsgenerated by operations. Trend strengthandflexibility by indicatinghowof financial longtheinstitutioncouldfunctionusing institution canaccessquickly andspendtosatisfyitsobligations. This ratioprovides asnapshot e Primary ReserveRatio xpenses andchangesinnetassets,ortheFASB statementofactivities; additionalinformation analysis ofthepublic institutionwouldxclusion oftheseentitiesfromfinancial resultinthe xpendable netassetstototalexpenses. Expendable netassetsrepresentthosethat the ASB practices,thesedifferences arefewer afteradoptionofGASBStatementNos.33,34and o wth initsoperatingsize.Expenses, ratherthanrevenues, areabetterindicator ofoperating GASB andFASB netassetclasscaptionsaregenerally similar. GASBunrestricted and requiredtocalculatetheratiosiscontainedinfinancial information The financial ratiosdescribedbelow combineentitiesthatfollowThe financial accountingpractices The Primary ReserveRatio measures the financial strengthoftheinstitutionby comparing measures thefinancial future financial flexibility.future financial resourcestostrengthenits increasing itsnetassetsandis likely tobeable tosetaside financial mission. Ontheotherhand, animproving trendinthisratio indicatesthattheinstitutionis may theinstitution’s beappropriateandeven if itreflectsastrategy warranted tobetterfulfill than inprevious years by measuringtotaleconomicreturn. declineinthisratio A temporary Return onNetAssetsRatio ov level ofexpenses. The trendofthisratioisimportant. A negative ratiooradecreasingtrend will provide asmallermargin ofprotectionagainstadversity as theinstitutiongrows indollar of growth inoperatingsize.Ifthey donot,thesamedollar amountofexpendable netassets ongoing programs. e debt netassets)isnotincludedbecausetheplantwillnormally besoldtoproducecash such asinterestexpense, plusFASB total expenses inthestatementofactivities. e accurate pictureofthefundsavailable totheinstitution. net wealth oftheinstitution,ratiosthatexclude nonexpendable netassetsprovide amore Although usingtotalnetassetsinthenumeratorprovides aninformative ratioastotheoverall e and FASB permanently restrictednetassetsarenotincludedbecausethey may notbeusedto restricted netassetsthatwillbeinvested inplant.GASBnonexpendable restrictednetassets restricted netassetsonaFASB basis,excluding netinvestment inplantandthosetemporarily ex Reserve Ratio relation tooperatingsizemay condition. Inthesecases,the signalaweak financial therefore produceanacceptable value forthe below. An institutionmay expendable have netassetsandlittleornodebt insignificant xcept inthemostextreme circumstancessince itpresumably willbeneeded tosupport xpenses andchangesinnetassetsincludingoperatingexpenses andnonoperatingexpenses foroperatingorplantexpenses withoutspecial legal permission. xtinguish liabilitiesincurred cluding thosetobeinvested inplant,onaGASBbasisplusunrestrictedandtemporarily er time indicates a weakening financial condition. er timeindicatesaweakening financial The The It isreasonable toexpect expendable totherate netassetstoincreaseatleastinproportion The carrying value ofplantequity(i.e.,GASBinvestedThe carrying incapitalassets,netofrelated The denominatorcomprisesallexpenses onaGASBbasisinthestatementofrevenues, The numeratorincludesallunrestrictednetassetsandexpendable restrictednetassets, The Return onNet Assets Ratio Primary ReserveRatio Primary ReserveRatio will be a much more valid measure of financial strength. will beamuchmorevalid measureoffinancial GASB Expendab GASB TotalExpenses A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS le Net also serves as a counterpoint tothe asacounterpoint also serves is calculatedasfollows: determines whether the institution is financially betteroff whether theinstitutionisfinancially determines Assets Vi plus plus a bility Ratio F FA ASB Expendab SB TotalExpenses . Butlow expendable netassetsin le Net Vi a bility Ratio Assets Primary discussed 21 RATIO ANALYSIS IN HIGHER EDUCATION 22 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS return onnetassetsmayreturn berequiredinordertomaintainaproperly capitalizedinstitution. calls foractivities thatwillconsumesubstantialresources,suchasprogram expansion, ahigh with eachratio,therearenoabsolutemeasures.For example, ifaninstitution’s strategic plan Research Associates, Washington, D.C.), However, willproducethenominalrateofreturn. as Consumer PriceIndex (CPI)ortheHigherEducationPriceIndex (HEPI)(published by approximately threetofourpercent. plustheactualinflationindex, eitherthe The realreturn possible. Rather, institutionsshouldestablishtarget intherangeof arealrateofreturn level ofinflationintheeconomy. targets isnot nominalreturn Therefore, establishing fixed ev to calculateatwo tothreeyear moving average significant toreducethevolatility ofspecific andevaluated. Someinstitutionsprefer fluctuationsneedtobe identified causes ofsignificant subtracts fromnetassets,thereby affecting the directly impactstheamountoffundsaninstitutionaddstoor ordeficit A large surplus how fromoperatingactivities affects thesurplus the behavior oftheotherthreestrategic ratios. institution isliving withinavailable resources?” indicator,This ratioisaprimary explaining answering thequestionposed earlier, ordeficit, surplus “Dooperatingresultsindicatethe Net OperatingRevenuesRatio v year-to-yearsubstantial giftorextreme investment canintroducesignificant performance, plansaremeasured.Single-yearperiod sothattheresultsoflong-term events, suchasa changes innetassetsandtheFASB statementofactivities. total netassetsthatcanalsobefoundintheGASBstatementofrevenues, expenses and net assetsandtheFASB statementofactivities. The denominatoristhebeginning oftheyear canbefoundintheGASBstatementofrevenues,This information expenses andchangesin assets regardless ofwhether they areexpendable ornonexpendable, restrictedorunrestricted. Assets Ratio olatility to this ratio. When interpreting the olatility tothisratio. When interpreting ents. The may returns basedontheprevailing bequitevolatileLong-term andvary significantly The The The The numeratoristhechangeinGASBtotalnetassetsplusFASB totalnet GASB OperatingIncome(Loss) Return onNet Assets Ratio Net Operating Revenues Ratio Net Operating Revenues Ratio Return onNet Assets Ratio , andthe GASB ChangeinNet GASB OperatingRevenues Vi GASB TotalNet Assets a plus bility Ratio plus F ASB ChangeinUnrestrictedNet Assets FA . , like alltheothers,isbetterappliedover anextended is calculatedasfollows: SB Total UnrestrictedIncome Assets is calculatedasfollows: indicates whether totaloperatingactivities resulted ina plus Return onNet Assets Ratio plus plus Net NonoperatingRevenues (Expenses) Primary ReserveRatio plus F F ASB ChangeinNet ASB TotalNet Assets Nonoperating Revenues , the (as withallratios) Assets Return onNet obligations asofthebalancesheetdate. forthisratiois: The formula the availability ofexpendable netassetstocover debtshouldtheinstitutionneedtosettleits VIABILITY RATIO toanacceptableand expense streamstoreturn management andthegoverning the institution’s boardshouldfocusonrestructuring income isawarning signalthat adjustments toprograms. ofdeficits A continuingdeclineorapattern quickly sapaninstitution’s strengthtothepointwhere itmay have financial tomake major initiativesleaders have toreverse can notidentified theshortfall. oflarge deficits A pattern may becalculated. v As discussedinthe plan inplacethatcuresthedeficit. strong,isaware andhasanactiveif theinstitutionisfinancially ofthecausesdeficit, indicates alossfortheyear. year may inaparticular berelativelyA smalldeficit unimportant mission-critical investments, achieved thenthesurplus shouldbequestioned. A negative ratio y Generally, thestrongerinstitution’s thelarger thesurplus, fromthe performance financial from restrictions. plus FASB totalunrestrictedrevenues, includingnetassetsreleased gains,andothersupport revenues, endowments, excluding capitalappropriationsand giftsandadditionstopermanent assets. e in unrestrictedassetsfromthestatementofactivities. not foroperatingactivities. For FASB relatedentities,thenumeratorincludestotalchange institution. Plantandendowment giftsandcapitalappropriationsareexcluded sincetheseare e revenues andexpenses, includinggovernmental appropriations,investment income,interest in netassetsandtheFASB statementofactivities. The numeratorincludesnonoperating xpense reflects a more complete picture of operating performance asitreflectsuseofphysicalxpense reflectsamorecompletepictureofoperatingperformance operatingactivitiesxpenses onplantdebtandoperatinggiftssincetheseitemssupport ofthe olatility thatmay bepresentinthisratioshouldconsideredandatwo tothree year average ear’s activities. However, areobtainedby under-spending asanoteofcaution,ifsurpluses on The arealmostalways deficits andstructural abadsign,particularly ifthe Large deficits A positive fortheyear. ratioindicatesthattheinstitutionexperienced anoperatingsurplus The denominatorisequaltoGASBtotaloperatingrevenues plustotalnonoperating The numeratorincludesdepreciationexpense. We believe thatinclusionofdepreciation The numeratorisavailable fromtheGASBstatementofrevenues, expenses andchanges The numeratoristhesameas the numeratorfor Vi a bility Ratio GASB Expendab GASB Long-Term Debt measures one of the most basic determinants of clear financial health: of clearfinancial measures oneofthemostbasicdeterminants A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS le Net Assets plus plus Net Operating Revenues Ratio F F ASB Expendab ASB Long-Term Debt euno Net Assets Ratio Return on Primary ReserveRatio le Net Assets . . , the 23 RATIO ANALYSIS IN HIGHER EDUCATION 24 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS Vi recorded atthesystemorother governmental unitlevel. Underthesecircumstances, the another entity. This may resultintheassets recordedattheinstitutionallevel while thedebtis these assetsasthoseliabilitiesarethelegal obligationdebt usedtoacquireorconstruct of plantassetswithnocorresponding governmental units,aninstitutionmay significant report objectives. ratherthanlong-term issues andshort-term itselfdriven rather thanprogrammatic by conditionwillfind fiscal continually fragilefinancial covenants requirements. anddebtservice financial An institutionina must bediverted tofulfill obligations tostudents,sinceresources itsmissionandmeetservice institution tofulfill f loans. obtaining short-term F time withhighdebtlevels andnoexpendable netassets—oreven negative netassetbalances. colleges collapse.Infact, anduniversities havepoint offinancial beenknown tosurvive fora a remarkable themtocontinuelongbeyond resiliency thatpermits what appearstobetheir Pa flexibility tofundnew objectives. sourcesandits resources diminishes,asdoesitsabilitytoattractcapitalfromexternal v aninstitution’sdiscussed earlier, canhelpdefine “margin forerror.” As the f operating,andprogrammatic objectives. other ratiosthatbalancesitsfinancial, The institutionshoulddevelopthat is“right”institution-specific. atarget forthisratioand objective thisrelationshipunacceptable. However, sincemostinstitutionswould find thelevel expendable netassetsto satisfy debtobligations,has sufficient thisvalue asan shouldnotserve and amountsborrowed forstudentloanprograms. courseofbusiness,suchasunexpended bondproceedsforplantpurposes to cashinthenormal itdoesnotinclude debt whose relatedassetsarecashorconvertible purposes; long-term the institution’s ofdebtusedfor portions andnon-current behalf.Itincludesboththecurrent also includeamountsowed agency asitrepresentsdebtissuedon toasystemorstate-financing the institution’s entities.Itwould andotherspecial-purpose foundations,partnerships affiliated credit, whether ornottheinstitutiondirectly owes theobligation. This would includedebtof andincludesallnotes,bonds,capitalleasespayableparties thatimpacttheinstitution’s inancial condition.Ultimately, conditionwillimpairtheabilityofan suchafinancial inancially viable. However, the alue falls belowalue falls 1:1,theinstitution’s abilitytorespondadverse conditionsfrominternal requently, thismeansliving andmeetingsevere withnomargin forerror cashflow needsby a yments ofotherliabilitiesmay similarly bedelayed. Highereducationinstitutionsoftenshow bility Ratio Based onthedifferent modelsusedby debtissuanceandreporting statesandother A scenariosuchasthatjustdescribedwillonly exacerbate theinstitution’s delicate anddoesnothaveMost debtrelatingtoplantassetsislong-term tobepaidoff atonce. There isnoabsolutethresholdthatwillindicatewhether theinstitutionisnolonger indicatesthat,asofthebalancesheetdate,aninstitution Although aratioof1:1orgreater fromthird asallamountsborrowed purposes forlong-term The denominatorisdefined may notbeapplicable totheindividual institutionsinceithasnoassociated Vi a bility Ratio , alongwiththe Primary ReserveRatio Vi a bility Ratio’s information. public andprivate, mustbeunderstoodandconsideredbeforemakingany conclusionsfromthe towhich theinstitutionaspires.Differencesfunds oragroup amongpeerinstitutions,both such asotherin-stateinstitutions,institutionsitcompetes withforstudentsorresearch GASB andFASB modelsnarrow. reporting addition, comparisonwithprivate institutionswillbecomeeasierasthedifferences between the amongpublic institutions.In information should beareductioninthevariability infinancial and relatedotherpronouncements,availability willincreaseandthere ofpeerinformation budget planning.Over timeandwiththeimplementationofGASBStatementNos.3435 oftheinstitution’spart stakeholders year-end andfornext process tocertain year’s reporting do comparedtoourcompetition?”Peer analysis oftheselectedratiosshouldbecomeacritical historical sourcesandusesoffunds,they donotanswer question,“How theimportant didwe forlongperiodsoftime. funds arereported While theseanalyses areusefulindetermining trendanalysis statementsininternal where sourcesandusesof fund accountingbasedfinancial there areany gaps. if net assetsshouldbepreparedandtheresultingratioscomparedwithgoalstodetermine budgets shouldalsoincludegoalsfortheselectedratios.Projectedandstatementsof with theinstitution’s organizations toarrive ataninstitution-wide budget. affiliated These common withprivate institutions. sheets arecalculated. entitiesandarebecomingmore These practicesarecommontofor-profit an “all-funds”budgetandeven fewer balancesheetmodeling where perform projectedbalance Some institutionsalreadypreparetwo tothree-year operatingbudgets.Few, however, develop plans. institutions, asthey develop financial strategic plans,shouldalsopreparecorresponding elaborationofthispoint. further targets forseveral key ratios.Pleasereferto“Strategic ManagementofDebt,” page27,for ofamorecompleteanalysis maypurposes beappropriate. isavailable,information “pushing-down” thedebtfromsystemtoinstitutionfor debt.However,long-term the The comparative analysis may becalculatedusinganinstitution’s historicalpeergroup Public institutionshave ratiosdeveloped generally fortheir usedtheKPMGLLPfinancial ofthebudgetingandplanningprocess,institutionsshouldcoordinate As part planningandbudgeting.Public term The fourstrategic ratioscanbealsousedinshorter The institutionshoulddevelop debt policy, andadoptaformal specific toarticulate inpart A NEWFRAMEWORK FORFINANCIAL ANALYSIS OFPUBLICINSTITUTIONS Vi a bility Ratio w ould be significant foranalysis ofthesystem.If ould besignificant 25 RATIO ANALYSIS IN HIGHER EDUCATION

V.

Strategic ManagementofDebt housing bonds,indirectcostrecovery bonds,etc.). revenues projects, ortopledgecertain totherepayment debt(e.g.,student ofcertain specific manage theirdebtexternally onaconsolidatedbasisbutmay berequiredtoallocatefunds obligation” bondswhen possible. Somepublic institutions,however, may notbeable to institution asawhole. Accordingly, we usually recommendthatinstitutions employ “general basiscanleadtolessfavorablemanaging capitalonaproject-specific debtutilizationforthe resourcesmoreefficiently.institutions moreflexibility toallocateinternal Incontrast, slightly longeraverage interestrateenvironments, lifefordebtincertain which offers fortheinstitution’s itsterms flexibility tostructure advantage. long-term This may includea beforeany department debt isincurred. internal repayment obligations internally andtodemandafeasible planforrepayment fromtheaffected debt andotherobligations. However, thisflexibility doesnotreducetheneedtoallocate activities, willbeitsflexibility tomanage thegreater allocation ofbudgetresourcestospecific within itsoperatingbudget. flexibility thattheinstitutionhastocontrol The greater debt affordability isgoverned moreby theinstitution’s abilitytoabsorballincrementalcosts actually burdenoninstitutionalresources. representagreater butalsothemaintenance,depreciationandprogrammatic costs,whichdebt service, may Planning fornew debtmustbedonewithcaresincethecostofanew isnotonly facility its future generationsthatareforcedtoassumeresponsibilityforprincipalandinterestpayments. How muchdebtcananinstitutionafford? the samefundamentalquestion: While theappropriateamountanduseofdebtdiffer acrossinstitutions,allleadersshouldask internally generatedfunds,government appropriations,contributedfundsandborrowed funds. fa as debtcapacitycovers toobroada rangeofactivities. Thus, theinstitutionwillprobably be activities situationislikely thatdonotenhanceitscompetitive toerode strengths,itsfinancial competitive goalsandbuildlong-term term advantages. Incontrast,ifthedebtisusedtofund themission,institutionwillbeinabetterpositiontoachieve tosupport itslong- incurred lenders andpurchasersofdebtevaluate itsabilitytoassume andrepay thedebt.Ifdebtis capital) strategically toadvance themission? resources toachieve goals. itslong-term institution remainsfocusedonitsmission,itcanuseleverage effectively todeploy additional Ifthe support. likely tohave andfinancial incompetingforstudents,faculty lost ground r ther away fromhaving theresourcesneededtoachieve itsstrategic objectives, andmore When debt is viewed on a portfolio rather than project-specific basis,thereisgreater When debtisviewed ratherthanproject-specific onaportfolio T While debtmay sourceofadditionalfunding,itis alsoaburdenfor provide asignificant Capital forland, buildings,andequipmentgenerally sources: comesfromfourprimary F ocusing onthisbroadconceptwillalsohelptheinstitutionunderstandhow analysts, oo often,institutionsfocusondebtcapacityfromabalancesheetperspective, although Has theinstitutionmanaged debt (andothersources of ST RATEGIC MANAGEMENT OFDEBT 27 RATIO ANALYSIS IN HIGHER EDUCATION 28 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION ST RATEGIC MANAGEMENT OFDEBT the question,“How muchdebtcananinstitutionafford?” possess substantially different levels ofdebtcapacity. There is,therefore,nosimpleanswer to ratiosmaylegal securityandhistoricgovernmental Institutionswithsimilarfinancial support. inassessingcreditworthiness,are important suchasthequalityofmanagement,specific isavailabledoes not,by whether debtfinancing itself,determine orappropriate.Othermatters as well. these(orany) ratios,adecreaseinoneratiooranincreaseanother Ininterpreting recommend thattheinstitutionfocusonaffordability by examining budget-relateddebtratios assets, isgenerally regarded asgoverning theinstitution’s abilitytoassumenew debt. We also more extensive discussion.) for planninganddebtutilizationtostrategicmanagement, facilities planning.(Seepage32 policy thatisadoptedbecauseitbuildsafoundationforlinkingcapitalbudgeting,financial amongthemanagersandusersofdebt,canbeeventrust morevaluable thantheactual perception ofinstitutionalcredit. We have foundthataninstitutionalprocess,which helpsbuild rather thanaperiodicactivity focusedsolely market onnew debtissuancesandthecurrent f provides aframework prioritiesandthemostappropriatefundingsources.In tohelpdetermine place. question why inthefirst theprojectisbeingundertaken if theinstitutionisunwillingtobackprojectwithallofitsresources,should all legally available Ontheotherhand, resourcestendstodecreasethecostsofdebtservice. it shouldreceive obligations creditfromthemarketplace tobepaidfrom becausestructuring other legally available resources.Iftheinstitutioniswillingtomake thiskindofcommitment, revenue ways streamproves torepay ofreallocating butwillfind thedebtservice insufficient we as aninstitutionalcredit,bothexternally andinternally. When debtisbeingusedstrategically, sources ofcapitalfundingandrepayment asbroadly as possible, and managetheirobligations Debt BurdenRatio debt atpublic institutions. The e e andthecostofborrowing relativeborrowed tooverall fundsasasourceoffinancing act, debt management should be an ongoing internal processthatincludesallstakeholders, act, debtmanagementshouldbeanongoinginternal xpenditures. Debt service includesbothinterestandprincipalpaymentsxpenditures. Debtservice onallobligations. withtheinstitution’sxpenditures. Itcomparesthelevel debtservice ofcurrent total

think thataninstitutionisunlikely to“walk away” fromanobligation iftheexpected Of thefourstrategic ratios,the In ordertomanagedebt,we debtpolicy that recommendthatinstitutionsadoptaformal Although notastrategic ratio,the To The

the extent thatfundsarefungible, we recommendthatpublic institutionsview their Debt Burden Ratio GASB TotalExpenditures GASB DebtSer is calculatedasfollows: Debt Burden Ratio Vi a Debt Burden Ratio bility Ratio vice plus plus , which focusesonthestatementofnet F e FA xamines theinstitution’s dependenceon ASB DebtSer SB TotalExpenditures is an important toolinmanaging is animportant vice access to capital. In certain cases, incurring debtactually improves cases,incurring access tocapital.Incertain creditdespite long-term ratiosactuallyinstances, institutionswith“weaker” enjoy financial highercreditratingsand represents only toevaluate onecriterionnecessary creditanddebtcapacity. inmany Infact, however, torememberthataninstitution’s itisimportant health andprojectedfinancial current ONECOMPONENTOFCREDIT ANALYSISFINANCIAL RATIOS: longer viewed asanobligation toretireasquickly aspossible. low-cost long-term, institutions sincedebtwillremainanimportant, sourceofcapitalandisno debtbeconsidered indecision-makingatpublic recommend thattheconceptofperpetual recommend itforallpublic institutions becauseofthenaturetheirfunding. We do,however, divided by totalexpenditures. amoreusefulratiowouldstructure, betocalculatetheinterestburden,thatis,expense than toimmediately retireoutstandingdebt.For debt institutionswhich useaperpetual initially repay principal,whichprojects thatarefinanced isrecycled tonew projects,rather obligation isonly interest.However, the budgetingandcost allocationpurposes, forinternal principalamortization. bullet maturityandnoexternal The institution’s annualdebt service debt.” “perpetual theobligationincorporate hasasingle,long-term, Under thisdebtstructure, Perpetual DebtandtheInterestBurdenRatio e e f In thiscase,thecontractualprincipalamount,which canusually befoundinthenotesto debt,thestatementofcashflows wouldrefinanced reflectalarge principalrepayment amount. GASB andFASB statementsofcashflows. However, has ifaninstitutionoraffiliate interest paid, year’s plusthecurrent principalpayments; bothgenerally areavailable fromthe context. have animpactonitsabilitytomake otherchoicesand, therefore,mustbeviewed inthis capital expenditures. decisionsmadebyThis ratiohelpsshow theinstitution thatallfinancial additional tradeoffsassist theinstitutionifitneedstomake budgetary inordertofinance since itprovides aclearerpictureoftheoverall flexibility available fortheinstitutionandto inancial statements,would bemoreappropriatetouse. xpense plus debt service principalpayments.xpense plusdebtservice principalpaymentsxpense plusdebtservice plusFASB totalexpenses lessdepreciation F Although many private institutionshave debt,we chosenperpetual donotnecessarily An emerging trendamongleadingresearchuniversities to istoaltertheircapitalstructure We The denominatoristotalGASBoperatingandnon-operatingexpenses lessdepreciation The numeratorofthisratioincludesinterestonallindebtedness,which iscalculatedby inancial ratiosprovide ausefulguideforevaluating thecreditofeducationalinstitutions;

believe tocalculate the itisimportant Debt Burden Ratio ST RATEGIC MANAGEMENT OFDEBT for theinstitutionasawhole, 29 RATIO ANALYSIS IN HIGHER EDUCATION 30 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION balance sheetstructures. directed transactions,executed leases, guaranteed anaffiliate’s long-term debtoremployed off- bonds, notesandleases,aninstitution may have foundation,enteredinto usedanaffiliated statements. Today Inadditiontotraditional structures. public institutionsusemany financing institutional debt? Definition ofDebt—Including“OffBalanceSheetFinancing” TRENDS INPUBLICUNIVERSITY FINANCING institution’s abilitytotake advantage opportunities. of important not appearparticularly burdensomewhen thebondsareissued, years laterthey couldlimitthe contracts frequently containoperatingcovenants andsecurityprovisions. Although thesemay the presentvalue savings. of debtservice However, insurancepolicies andotherfinancial analysis of thecostofinsuranceand bond transactionisgenerally basedona cost-benefit covenants andpledgesofcollateral.For example, thedecisiontousecreditenhancementfora is criticaltoachieving missionobjectives. inability toaccurately quantifyfuturevalue. Nevertheless, futureoptions afocusonpreserving worth. flexibility, Itisvitaltopreserve flexibility,significant includingfinancial despitethe a tooltoprovide theinstitutionwithflexibility torespondthefuture,which isof certainly willbechangesto budgetsandprioritiesastheyears unfold. as The ratioshereserve there guidetofutureperformance, statementsprovide abeneficial although projectedfinancial positioned todealwithproblems,andadjustcosts.Furthermore, capitalizeonopportunities, Determinants ofCreditProfile creditprofile. itstrue determining ratios,in components ofitsoperationalandprogrammatic characteristics,includingfinancial negative ratios. causing ashort-term effectThe institutionshouldevaluate onspecific many At onetimeitwas relatively easytoanswer thequestion, When bondissuesarestructured, toanalyze itisalsoimportant thepotentialimpactof plansandanalyzingBy developing projectedratios,theinstitutionisbetter financial One simply looked atthe bondsandnotespayable in thefinancial Competitive Advantages Academic Caliber T Security of ransactions Legal Amount Debt of Financial Strength Management Support State Quality ST of What istheamountof RATEGIC MANAGEMENT OFDEBT minimizing thefrequency of,anddependency on,bondtransactions. assistin managingasourceofavailablecommercial paperprogram canfurther fundswhile number ofadvantages. Dependinguponthesizeofinstitution,abanklinecreditor lowering overall institutionalcostsandrisksproviding apredictable funding costhasa costs mustbeconsidered.However, basiswith theobjective managingdebtonaportfolio of infrequently. reviewed regularly althoughwe recommendthattheactual ratesshouldbeadjusted or donorrestrictions),andreducedadministrative burden. repaymentThe internal rate is prevailing market conditions(subjecttotaxlaw, federalreimbursementrequirementsandstate reduced year-to-year tooptimize budgetvariances; debtthatcanbestructured external suchas disbursement canhelpalleviate theproblem offundingtimingandproducebenefits projectsatacommonrepayment rate. to individual tofinance departments This methodof management ofdebtby having theinstitutionfunctionasacentralbankandlenddebtproceeds Increasingly, institutions(includingsomepublic ones)have approachedtheissueofinternal e v f project’s costisbasedonluck,prevailing debtservice market conditionsandthetypeof fundingsource. basis andindividualThus, a projectsareallocatedfundingfromaspecific External Versus InternalManagementofDebt the institution’s mission,driving thedecision. and away fromthecreditanalysts, itisnotasdesirable sinceitisthetransaction,ratherthan istokeep atransactionoff-balance structure sheet sole motivation financing foraparticular However,buildings, suchasoff-campus housing,researchorparkingfacilities. graduate ifthe risks. For developer example, choosingathirdparty may helpreducethecostoffinancing andpotential isbeingconsideredandtounderstanditsobjectives,structure expected benefits essentiality oftheassettoaninstitution’s thelikelihood itis“on-credit.” mission,thegreater accounting treatment;rather, itistheessentialityofrelatedasset. the The greater onthebalancesheet,shouldbeincluded. transactions arenotreported achieve itsmission,allobligations thatuseaninstitution’s debtcapacity, even ifthese inancing employed (e.g.,equity, gifts,tax-exempt or loans,fixed debt,taxable debt,third-party xtremely difficult andcanleadtoinequitiesamongvariousxtremely institutionaldivisions. difficult ariable rateobligations, etc.). Implementing an enterprise-wide structure canbeachallenge, ashistoricalbudgetsand structure Implementing anenterprise-wide makes budgetingandprojectplanning structure This project-by-project financing T decision,we financial encourageleaderstoaskwhyAs withany financial aspecific The ultimatetestofwhat northe constitutesoutstandingdebtisnotthelegal structure ofassessinganinstitution’sIn consideringdebt,particularly interms abilityto long-term ypically, public institutionsandotherborrowers have issueddebtonaproject-by-project ST RATEGIC MANAGEMENT OFDEBT 31 RATIO ANALYSIS IN HIGHER EDUCATION 32 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION ST RATEGIC MANAGEMENT OFDEBT support andacceptanceacrosstheinstitutionforprocesspolicy tobetrulysupport effective. withresponsibilityforleadingtheprocessneedtoenlistbroad officers andthefinance specific schedules),theprocessisoftenintensivesupporting becauseeachpolicy mustbeinstitution- management ofdebtaswell guidelinesandallocationprocesses. asinternal objectives, debtpolicy every regarding institutionshouldadoptaformal boththeexternal discipline has gained wide recognition and support among external stakeholders.discipline hasgainedwiderecognition amongexternal andsupport reviewed. mentioned above, thisarticulated benefits Inadditiontothe substantialinternal PROCESS OFDEVELOPING AN INSTITUTIONAL DEBTPOLICY e from better positionedtobeartheinterestrateriskthanonanindividual project,andbenefit v ratesrise. ifshort-term Also, alessfavorablesubstantial difficulty allocationbetween and fixed not have riskthey evaluated assumedandtheirprojectsmay encounter thesignificant probably enjoyed substantialcostsavings (atleastinthelate1990sandearly 2000s),butmay on atransactionbasiswiththeactualinterestexpense passedthroughtousers,theseusershave institutions, itisdesirableofthedebtatvariable tomaintainaportion rates.Ifdebtismanaged xposure tovariable rates. ariable ratedebtmay beemployed. basis,theinstitutionis Bymanagingdebtonaportfolio The processfordeveloping adebtpolicy requiresbothanalytic and“softskills”including: Although debtpolicy statementsaregenerally (usually pagesplus short nomorethanfive The debtpolicy mustbehelpfultomanagement, regularly communicated, andperiodically the outputofongoingprocess. and stakeholdersCommunicating throughouttheprocesswithexternal aboutthebenefits re-evaluated and (without unintendednegative relationshipsmustbe results)andwhether existing financial intothenew how priordecisionsandstructures frameworkDetermining toincorporate Ensuring thatalldebt-fundedprojectshave anapproved repayment internal plan, theinstitution’sDeveloping apolicy thatfits businessneedsandculture, Evaluating andobligations, existing debtstructures e Overcoming any resistanceandskepticism (which may ofan necessitatetheintervention culture, Understanding thehistoricrelationships,decision-makingprocessesandinstitutional To andvariableThe decisionsregarding fixed ratedebthighlightthispoint.For most xternal party), xternal

ensure thatdebtisusedmosteffectively toadvance institutionalmissionandstrategic the following guidelinesshouldbeconsidered: allinstitutions. However,there isnoonemodeldebtpolicy thatfits indeveloping adebtpolicy, Establish apolicyregarding theinternalutilization,management and repayment ofdebt. w Include themethodology andcalculationstosupporttheitemscontainedinpolicy, as highest acceptable credit rating. State thattheinstitutionwillinteract withtherating agencies andstrivetoattainthe e Contemplate theuseofderivativeproducts andestablish guidelinesregarding their percentages. structures andcovenants. Consider themixofvariable debtaswell aspermissible andfixed (orprohibited) debt related and(b)have arelatedrevenue streamforrepayment. management flexibility; however, thepolicy shouldprioritizeprojectsthat(a)aremission- other operating levels oftheinstitution. Develop apolicyfor theprioritizationofcapitalprojects withinputatthedepartmentand usefulfromamanagementperspective. that theinstitutionfinds strategic level. hereorotherratios The ratiosmightbethefourstrategic ratiosidentified used torepresenttheoverall health oftheinstitutionandtokeep theevaluation atahigh, boundaries oftheinstitution’s operations. Select thefew key ratios targets andestablish financial for thedesired specific financial other componentsofthepolicy. acceptable. Itprovides criteriaformanagementandthegoverning the boardtointerpret govern ofdebttoachieve theincurrence strategic objectives andwhere deviations are institution. Articulate theinstitution’s philosophy about debtthatgoverns allcommitmentsofthe Because thepolicy shouldreflecttheinstitution’s uniqueneedsandstrategic objectives, specific rating as part ofthepolicy. ratingaspart specific valuation, aswell asany othertypeofoff-balance sheet debt. ell asacalculationoftheratios (including projections), asappendices. This shouldexplain why thedebtpolicy isbeingcreated, how itwillbeusedto Ta r gets should be established for fixed andvariablegets shouldbeestablished forfixed ratedebt The institutionshould Guidelines shouldbebroadenoughtoallow Generally, nomorethanthreeorfour ratiosare not ST RATEGIC MANAGEMENT OFDEBT specify theattainmentofa 33 RATIO ANALYSIS IN HIGHER EDUCATION

VI. CommunicatingFinancialDecisions mission. Somenotesonthecontext ofthismodelareimportant: aligned withinstitutionalgoals. these issuesinacontext thatprovides aconsistentandrepeatable basissothatresourcesare issues mustbedealtwitheffectively. However, thechallengeforleadersishow todealwith requirements), ratherthanaplannedprogression toward goal. apreviouslyThese defined access, investment innew technology, unexpected maintenanceorsecurity facility reaction tootherevents (e.g.,suddenreductioninstateappropriations,legislative mandatefor the institutionrisksdiffusion ofitsresources.Sometimesresourcedecisionsaremadein initiatives. Anytime adecisiononresourceallocationismadeoutsidethecontext ofmission, and satisfytheirvarious stakeholders, yet narrow enoughtoensurethequalityoftheirprogram of“university” or“college” thetraditionalandhistoricdefinitions activities broadenoughtofit Allocating FinancialResourcestoMission below willassistleadersconfrontedwiththeseissues. witheitherthedecisionorrationaleboth. agree We believe thatthetwo modelspresented decisions andtheirrationaleformakingthesetostakeholders, many who willnot w sacred traditions.Inotherwords, thewinnerswillbethoseinstitutionsthatarewell led, notjust theircorevalues while alsopreserving challengesintoopportunities, and change, turning by constantly changing,always challenging,andfrequently threateningtimes,theracewillbewon According toMorley andEadie,in achievement oftheinstitution’s missionortoresultinabandonment ofitsstrategic plan. resources. These decisionsoftenhavereduced financial thecapacity toimpedethe implications toitsstakeholders. g reater insights from financial information and help communicate the information andits andhelpcommunicatetheinformation information reater insightsfromfinancial ell managed.” obstaclesincommunicatingresourceallocation significant Leadersface

the mostcreative, innovative, nimble andflexible institutionsthatareable toleadtheirown Presented following is a modelthatmatchesresourceallocationdecisionstoinstitutional task:they mustfocusresourcesonabandof Public adifficult educationalinstitutionsface issuesthatleaderscontinuously isallocatinglimitedor One ofthemostimportant face The goalofourefforts inthispublication istohelpleaders ofpublic institutionsderive the mission and financial performance. It doesnotconsideractivities performance. withinthe unit. the missionandfinancial intwoThe modelentailsrankingeach department to independentdimensions:importance departments. division unitswillbe level. ordepartment For ofthisdiscussion,thedefined purposes university system,itmightbetheschoolordivision level. For aschool,itmightbethe unitlevel tobemeasured. ForThe modelrequiresselectingthespecific auniversity or planning process. To

ensure effectiveness, ofthe strategic thismodelshouldbeimplementedaspart The Extraordinary HigherEducationLeader COMMUNICATING FINANCIALDECISIONS , “Inthese 35 RATIO ANALYSIS IN HIGHER EDUCATION 36 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION COMMUNICATING FINANCIALDECISIONS relevant data atthemeasurable unitlevel. institution, but,moreimportantly, itsexpectation forthefutureandability toaccumulate situationofthe performed. financial This diagnosis shouldconsidernotonly the current select itskey indicators,adiagnostic todevelop performance theindicatorsshouldbe receivingscore, lowest performance thelowest financial score.Becauseeachinstitutionmust f onnetassets,etc. items suchasoperatingresults,budgetsize,return The departmental willdependonwhat theinstitutionviewsperformance ascritical,andmay beacombinationof FINANCIAL PERFORMANCE AXIS businesscase. bysupported aspecific to monitorandmeasureinstitutionalsuccessmay beimproved becausethedeviation is ifabusinesscaseforthedeviation theability the modelarenotharmful Infact, issupportable. and (b)make decisionswithinthe framework ofthemodelonceimplemented.Deviations from mission, directly tothe ability ofmanagementto:(a)focusonaclearly proportional defined resources have Managementdrives occurred. thismodel,anditssuccessfulapplicationis allocated, itcanalsobeappliedwhen “disinvestments” mustbemadeorreductionsinfinancial Relationship ofResourceAllocationtoMission inancial performances are ordered — highest financial performance receiving performance thehighest areordered —highestfinancial inancial performances The vertical axis represents financial performance. The definition of financial performance. The definition axisrepresentsfinancial The vertical Although thismodelisbestsuitedwhen additionalinvestments aremadeorresources circumstancesarise. units andsuggestscoursesofactionwhen certain units. Rather, itprovides guidanceonsettingprioritiesforallocatingresourcesamongthe The modeldoesnotsuggestanamountofresourcestoallocateaunitoramongthe

Financial Performance Less Important motn Critical Important Quadrant 3 Quadrant 1 Quadrant 3 Quadrant to Future Quadrant 4 Quadrant 2 Quadrant 4 Quadrant Mission Important to Future V ery quadrant andsomeofthesuggestedactionsthatmay evolve: the institutionwhen makingitsnext decisions. The following summarizesthe meaningofeach MODEL APPLYING THE into accountallofthecomponentsmission. programs, etc. education, graduate Whatever model isusedrequiresascoringsystemthattakes andsciences,business, their missionalongbroaddisciplinessuchasarts Others may define publicresearch,andpatientcare. along broadlinesofbusiness,suchasinstruction, service, implementation ofthismodel. activities andrankingthemonthemissionaxisiscriticaltosuccessful ordepartments institution’s themission-critical capabilities.Determining aspirations,andtheexisting internal view diagnosticisrequiredthatfocusesontheexternal oftheinstitutiontoday,specific the byconstituencies, ordesirestobeidentified, itshighestratedactivities. Again, aninstitution- Rather, inthemarketplace andamongitskey itrecognizes thattheinstitutionis identified toinstitutionalmission. to importance This rankingdoesnotmeanadisciplineisvaluable. inrelation stepistorankthedepartments ordered again. first The critical,andmostdifficult, relation totheinstitutionalmission.For mustbe thismodeltobeuseful,eachdepartment MISSION AXIS will be1through20. thescores convert scoreto aranking.Ifthereare20departments, thecalculateddepartment conversion toacommonscale,andweighting plan. A key tousingthismeasurementis b several years asthekey measure.Institutionsmay alsouseaselectednumberofcriteria, capacity orabilitytoborrow may capitalrequirementsover useexpected departmental thenext ke operationsasthe margin andlimitedretainedresourcesmay netfinancial selectdepartmental reflected intheselectionofthesecriteria. As an example, aninstitutionwithlittleoperating implementing thismodel.Eachinstitutionconfrontsuniquecircumstances,which shouldbe lended together, results. toproducemoreinformed This would requireaselectionprocess, y measurebecausethereislittleresourcetoallocateothers.Institutionswithdebt Arranging the departments by combining financial performance andmissionhelpsfocus performance by thedepartments combiningfinancial Arranging SomewouldMany theirmissionasmultifaceted. institutionswould apply this define The horizontalaxisrepresentstherelative occupiesin positionthateachdepartment successiscriticalto criteriaforfinancial The selectionofinstitution-specific the institutionaldebtpolicy, additionalstateappropriations orfundraising. oftheinstitutionthatwillbe focusof quadrant willmostoftenrepresent theportion inthis among thehigherprioritieson requestsforinstitutionalresources.Departments They cangenerally afford someoftheirown reinvestment, butshouldbeconsidered performance. ofbothinstitutional missionandfinancial interms departments performing Quadrant 1—CriticaltotheFuture. Departments inthisquadrantarethehighest Departments COMMUNICATING FINANCIALDECISIONS 37 RATIO ANALYSIS IN HIGHER EDUCATION 38 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION COMMUNICATING FINANCIALDECISIONS of fundingfortheseactivities. sinceinstitutionalresourceswould return, source notbeaprimary this toincludefinancial encourage program expansion andaddedpersonnel,butwould expect thebusinesscasefor done withinthecontext oflimitedinstitutionalresourceallocation. The institutionwould may However, becandidatesforalliancesandpartnerships. thesewould mostlikely be When aninstitutionthinksaboutpotentialgrowth Quadrant3departments opportunities, k meaningfulways membersand institutional challengeistofind ofretaining faculty its own tendtobehighly resources.Inmost institutions,thesedepartments productive. The ofthe investmentthe institutionmay fundsomeportion requestthatthedepartment from fundinvestmentswith thesuggestionthatthesedepartments outoftheirown or, returns; request institutionalresources,theresponseofafocusedinstitutionmay well benegative butscorelower performance inthisgrouping onmission.Ifdepartments higher financial totheFuture.Quadrant 3—Important risk. sharing offinancial relationshipswouldstructured allow advancement ofinstitutionalmission,withpotential andalliancesbecausewell- candidatesforpartnerships aretheprimary These departments f they success have againstkey notdemonstratedstronghistoricalperformance financial benchmarks. That processmay inthisquadrantbecause bemorecriticaltodepartments Quadrant 1,thereneedstobeclosemonitoringofinvestments madeagainstpredetermined becauseofthepotentialimpactonachievementperformance ofmission. As with in thisquadrantshouldnotbelikely cutstoimprove candidatesforbudgetary financial such asanalyzing spaceallocations,capitalequipmentneedsandpersonnel.Departments step may performance, well betoassesswhat theinstitutioncandotoenhancefinancial achievement performance. ofinstitutionalmissionbutareweakerThe first onfinancial Quadrant 2— Very totheFuture. Important mission. will beartheriskofdilutionitsresponseinareasmostcriticaltocompletion on abasisthatallows theinstitutiontodrive therelationship.Otherwise,institution may but Quadrant 1departments becandidatesforcreationofalliancesandpartnerships, continuinginvestments. there needstobeaplanredefining advance theinstitutionalmission.Ifinvestments arenotachieving benchmarkgoals, mostlikelyinstitutional progress againstmissionbecausethesearethedepartments to measure successagainstthosebenchmarksatregular intervals. Itiscriticaltomeasure f beforetheinvestmentsthese departments aremade. The benchmarksarebothnon- The institutionshouldestablish benchmarksofexpected resultsforinvestments madein actors. inancial (as drivers) and financial (to determine affordability). (todetermine inancial (asdrivers)The institutionmust andfinancial eeping themfully motivated asnew resources areallocatedtootherareas. Departments inthisquadranthaveDepartments relatively Departments inthisquadrantarekeyDepartments to date, oranincreasedriskmay exist thatkey strategic initiatives willnotbemet. obligation thattheinstitution willbeforcedtomake upat alater represents atypeofdeferred should understandthatastrategic gapexists inbalancingthebudget.Generally speaking,this represents substantive change,thentheboard, senior managersandotherinterestedparties objectives. Iftheoperatingplantendstobeincrementalinnaturewhile thestrategic plan impliedbythe spendingpatterns theoperatingbudget indicateprogress toward strategic required by theinstitution tomeetitsmission. success oftheinstitution,relatestotypesannualinvestmentsterm andreinvestments budget isbalancedfromastrategic perspective. The distinction,which iscriticaltothelong- focus onan“accountingbalance”ofthebudgetwithoutnecessarily focusingonwhether the and oftenunpredictable changestostateappropriations. This balancingactivity hastendedto higher education. This isespecially forpublic institutionsthathave true todealwithsignificant BALANCING THE BUDGETSTRATEGICALLY The questionofwhether abudgetisstrategically balancedisanswered by theways that withthedilemmaofhowInstitutions areoftenfaced tocreatea“balancedbudget”in apply thistothenext threeyears. year). Institutionsthathavecurrent created reasonable predictive modelsmay alsowishto past threeyears may make themostsense(withsomeweighting emphasisonthemost axisofthemodel;formany institutions,the select atimeperiodforapplying thefinancial Applying thisconceptualmodelrequiresseveral stepsanddecisions. The institutionmust 2 willprovide totheinstitutionfromamissionperspective. returns thegreatest elsewhere. toQuadrants1and Also, thereallocationofresourcesfromthesedepartments oreven andmay long-term accomplishment intheshort-term drainneededinvestments or mission made tounitsinthisquadrantarenotlikely return toresultingreater will have theleastnegative effect investments onachievement ofmission.Significant likely candidatesforcontainedoperatingandcapitalbudgets,becausetheseconstraints mission would only beimproved inthisquadrantare onalimitedbasis.Departments improvements,appear inconsistentbecause,regardless theinstitutional offinancial would throughalliancesandpartnerships Actions suchasstrengtheningthesedepartments contractors,etc.). third-party issues, capitalinvestments (e.g.,athleticleagues, researchassociates, partners andexternal to belongerthanayear. Factors affecting tenure thisdecisionincludeyears tograduation, constituency andstaff sincetheinstitutionhascommitmentstostudents,faculty thattend cycle” thatithascommittedtotheaffected the“service determine institution mustfirst additional institutionalresourceswould likely bedenied.Inplanningchange,the timeandthatrequestsfor over departments become“service” departments somedefined itsmission.Possible actions mayassisting theinstitutioninfulfilling well bethatthese indicators and arescaledrelativelylowest performance lower resultsonfinancial on totheFuture.Quadrant 4—LessImportant Departments inthisquadrantproducethe Departments COMMUNICATING FINANCIALDECISIONS 39 RATIO ANALYSIS IN HIGHER EDUCATION 40 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION COMMUNICATING FINANCIALDECISIONS Identifying StrategicGaps covered by thestrategic plan. cumulative innature,andtheinstitutionshouldtracksizeofthatgap,ifany, over theperiod the strategic planandthosefundedinabalancedbudgetdevelops. The strategic gapis f little investment instrategic initiatives. Ifrevenue sourcesmeetthisline,thebudgetis strategically balanced. The secondlinerepresents abudgetthat“getsthejobdone”butincludes objectives ofitsstrategic plan.Ifrepeatable revenues meetorexceed thisamount,thebudgetis the expenses ofaninstitutionthatisreinvesting tomeetthe initselfataratesufficient to createnew skillsthatarerequiredby theinstitution’s strategic plan. andstaff Itoftenrepresentstheactivitiescontext, forfaculty israrely support. necessary salary capital, humancapitalandnew program initiatives. The investment inhumancapital,this should presentinstitutionalinvestments, by specialinvestment, inthreecategories: physical methodology, sinceitalignsaccountabilityandresponsibility. A supplementtothebudget strategic investments aremade,particularly innew initiatives. This isareasonable budgetary accordingtoactivity, anddonotcaptureinformation departments, which istheway most objectives. Budgetsaregenerally lines,usually preparedconsistentwithreporting by Expenses inancially balanced.Over aperiodofyears, astrategic gapbetween costsneededtoachieve The following presentstwo chart linesidentifyingstrategic gaps. The toplinerepresents processprovidesThe typicalbudgetary aboutmeetingstrategic limitedinformation 1 234 5

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d Strategic Gap http://www.prager.com. programs thatsupportachievement oflong-termcompetitiveadvantages. Our Web siteis objectives andassistinginthedevelopment andmaintenanceof internalpractices andfinancing [email protected]. c National HigherEducationPractice, Prager, McCarthy &Sealy, LLC,(415-403-1909), discussed inthispublication shouldbe directed toChristopherJ. Cowen, Managing Director, Contact Information We providing comprehensive debtmanagement servicesandadvicetohighereducationalinstitutions. http://www.us.kpmg.com. more than108,000professionals, including 7,000partners, in159countries.KPMG’s Web siteis LLP istheU.S. ofKPMGInternational.International’s memberfirm have memberfirms insights thathelpthemstayaheadofthecompetitionandachieve market-leading results. KPMG global economy. We helpourclients bydevising results-oriented businessstrategies, providing [email protected], orIngrid A. Stanlis,Partner, KPMG LLP(716-263-4015),

help our clients by first developinghelp ourclients athorough byfirst understanding oftheir uniquestrategic Comments, questionsorrequests for additionalinformation concerning any oftheissues Prager, McCarthy &Sealy, specializingin servicesfirm LLCisafull-servicefinancial thatunderstands theneedsofbusinessin KPMG LLPistheaccountingandtaxfirm VII. NextSteps Education. education leadersandlookforward todeveloping thenext phaseof organizations anticipated. thatarenotcurrently We welcome discussion withotherhigher may prove controversial. FullimplementationofGASBNos.34and35may reveal issuesfor higher education finance and develop additional tools for the benefit ofpublic institutions. anddevelop additionaltoolsforthebenefit higher educationfinance new standardsthat may reporting affect creditanalysis. We willcontinuetomonitortrendsin public institutions.Ratingagenciesaredeveloping new methodologies totake intoaccountthe f strategic questionsandtoexplore ways ofcombiningratiostohelpcommunicatetheoverall e statementsissuedunderGASBStatementNos.34and35. We financial public institutions’ Sealy, LLCwillcontinuetodevelop thesemethodologies andframeworks afterreview of f management andresourceallocations,withafocusontheuseofratioanalysis informulating institutions andoffers leadersofpublic institutionsnew perspectives andapproachestodebt inancial healthoftheinstitution. inancial planninganddebtpolicy fortheinstitution.KPMGLLPandPrager, McCarthy & xpect toconsideradditionalratioswhich may provide additionalinsightstoanswer thekey We Strategic managementofdebtpracticescontinuestodevelop andevolve, especially for ratiomodelandframeworkThis publication introducesanew financial forpublic

also recognize that this specific frameworkalso recognize thatthisspecific andtheselectionofthesestrategic ratios Ratio Analysis for Higher NEXT STEPS 41 RATIO ANALYSIS IN HIGHER EDUCATION

Appendix: RatioCalculations plus FASB ChangeinUnrestrictedNet Assets Net OperatingRevenuesRatio Return onNetAssetsRatio Primary ReserveRatio Numerator: Adjusted NetOperatingRevenues +F - GASBNonoperatingExpenses + GASBOtherNonoperatingRevenues + GASBNonoperatingInvestment Income + GASBNonoperatingGifts + GASBNonoperating Appropriations + GASBOperatingIncome(loss) Numerator: GASBOperatingIncome(Loss)plusNetNonoperating Revenues (expenses) Denominator: TotalNet Assets + F +GASB Total Net Assets (beginning ofyear) Denominator: GASB Total Net Assets plusFASB Total Net Assets: Numerator: ChangeinNet Assets + F + FASB Increasein Temporarily Net Assets + FASB IncreaseinUnrestrictedNet Assets + GASBIncreaseinNet Assets Numerator: GASBChangeinNet Assets plusFASB ChangeinNet Assets Denominator: TotalExpenses +F + GASBNonoperatingExpenses +GASB OperatingExpenses Denominator: GASB Total ExpensesplusFASB Total Expenses Numerator: Expendable Net Assets +F - FASB Property, PlantandEquipment,net + FASB Temporarily RestrictedNet Assets + FASB UnrestrictedNet Assets + GASBExpendable RestrictedNet Assets (excluding thosetobeinvested inplant) + GASBUnrestrictedNet Assets Numerator: GASBExpendable Net Assets plusFASB Expendable Net Assets ASB IncreaseinUnrestricted Net ASB Expenses ASB Long-ter ASB ASB IncreaseinP T otal Net m Debtin Assets (be er manentl v ested inplant ginning ofy y RestrictedNet Assets ear) Assets APPENDIX 43 RATIO ANALYSIS IN HIGHER EDUCATION 44 NEW INSIGHTS FOR PUBLIC HIGHER EDUCATION Debt BurdenRatio V Unrestricted Income iability Ratio Denominator: TotalExpenditures + F -FASB DepreciationExpense +FASB TotalExpenses + GASBPrincipalPayments - GASBDepreciationExpense + GASBNonoperatingExpenses + GASBOperatingExpenses Denominator: GASB Total ExpendituresplusFASB Total Expenditures Numerator: DebtService + F + FASB InterestExpense + GASBPrincipalPayments + GASBInterestExpense plusFASBNumerator: GASBDebtService DebtService Denominator: Total Debt Long-term + F portion Liabilities–non-current + GASBLong-term portion Liabilities–current + GASBLong-term Denominator: GASBLong-Term DebtplusFASB Long-Term Debt Numerator: Expendable Net Assets +F - FASB Property, PlantandEquipment, net + FASB Temporarily RestrictedNet Assets + FASB UnrestrictedNet Assets + GASBExpendable RestrictedNet Assets (excluding thosetobeinvested inplant) + GASBUnrestrictedNet Assets Numerator :GASBExpendable Net Assets plusFASB Expendable Net Assets TotalDenominator: Adjusted Income +F +FASB Total UnrestrictedRevenues andGains + GASBOtherNonoperatingRevenues\ + GASBNonoperatingInvestment Income + GASBNonoperatingGifts + GASBNonoperating Appropriations + GASBOperatingRevenues Denominator: GASBOperatingRevenues plusNonoperatingRevenues plusFASB Total ASB Long-ter ASB Net ASB PrincipalP ASB PrincipalP ASB Long-ter Assets ReleasedfromRestrictions m Debtin m Debt a a yments yments v ested inplant APPENDIX 02350MVL