Answering Key Financial Questions
for Board and Management through
Effective Internal Financial Reporting
Ron Salluzzo
Phil Tahey
Outline and Outcome
Session Outline
• Role of Internal Financial Reporting
• Concepts to Consider in Developing an Internal Reporting
Program
– Financial health measurements
– Internal reporting concepts
• Management Discussion and Analysis
• Questions
Session Outcome
• Learn a different approach to internal reporting by
focusing on key information, risks and metrics
2
Audience Questions
• Are you from a...
– Public Institution?
– Private Institution?
• Do you think your Board members understand higher
education industry finances?
– Your Institution’s financial issues?
– Your Institution's key financial risks?
• When was the last time you revised your internal reporting or
reports?
• Does your internal reporting consist primarily of budget –
actual statement of activities and explanation of variances?
3
Role of Internal
Financial Reporting…
• Internal financial reporting provides methods and tools to evaluate
financial risks, condition and operations, and communicate
information effectively to institutional stewards at various levels
• Several financial questions* that institutions should address are:
–
–
–
–
–
–
–
How has the Institution responded to its strategic financial risks?
What is the institution's liquidity and how does it affect operations?
Is debt used strategically?
What are the financial operating risks and how are they managed?
What are the financial capital risks and how are they managed?
Are financial resources allocated to support strategies?
What is the institution's overall financial health?
*From Strategic Financial Analysis for Higher Education, Seventh Edition
DRAFT
4
…As Opposed to External
Financial Reporting Objectives
• FASB Concepts Statement No. 4, “Objectives of Financial Reporting by
Non-business Organizations” issued in 1980 stated that information
should be provided to present and potential resource providers and other
users about:
–
–
–
–
–
Allocation of resources
Assessing the services provided and the ability to continue to provide those services
How managers discharged their stewardship responsibilities and their performance
Economic resources, obligations and net resources, and the changes therein
Performance of the organization for the period
• GASB Concepts Statements No.1 “Objectives of Financial Reporting”
issued in 1987 stated that financial reporting should assist users in:
– Assessing the unit’s public accountability
– Evaluating operating results
– Assessing the level of services provided and the unit’s ability to meet obligations as
they become due
5
Internal Reporting as part of
Strategic Plan Monitoring –
Mission to Processes
6
Linkage of Strategic Financial
Risks to Internal Reporting
Identify and Assess
Strategic Financial Risks
Implement Monitoring
and Mitigating Activities
Establish Internal Financial Reporting
Objectives to Communicate those
Activities
Develop & Communicate Financial &
Non-financial information to meet the
Objectives
DRAFT
7
Primary Objectives of Internal
Financial Reporting
• Internal reporting is focused on reporting information related to
strategic financial risks and key information in order to answer the
high level questions
• Primary objectives of internal reporting are:
– Report Stewardship over Sources and Uses of Funds
– Financial Performance
– Liquidity – Balances, sources, uses, needs
– Capital Asset Acquisition and Financing
– Financial Capital Structure, Leverage and Capital Availability
• Objectives are broad and cover diverse aspects of an institution
DRAFT
8
Reporting Information to
Meet Objectives
• Existence of restrictions on use of a significant portion of funds
and revenues adds a layer of complexity not in for-profit
companies
– Government grants and funds for research, tuition or clinical care
– Endowments and related pay-out
– Current or plant contributions
• Due to diverse objectives and presence of restrictions, one basis
of reporting cannot meet all objectives effectively
• As a result, three bases or perspectives are needed
– Funds - GAAP - Cash
DRAFT
9
Reporting Information, cont.
• Each basis of reporting is more effective at meeting certain
objectives
– Funds Basis
• Stewardship over Funds received
• Capital Asset Acquisition and Financing
– GAAP Basis
• Financial Performance
• Capital Structure
• Capital Availability
– Cash Basis
• Liquidity sources, uses, needs
DRAFT
10
Levels of Financial Information
• Different levels of users of financial Reports
–
–
–
–
–
–
Trustees
Senior central management
Divisional senior management
Departmental management
Faculty members
Middle central management
• Although one set of reports cannot meet needs at all levels,
basic information will be the same
– Difference is in level of detail and grouping of information
DRAFT
11
Levels of Financial
Information Pyramid
TRUSTEES
SR. CENTRAL MGMT
DIVISIONAL MGMT.
DEPARTMENTAL MGMT.
FACULTY & STAFF
DRAFT
12
Putting It All Together
• In order to meet the Reporting Objectives, significant
changes are needed
• At the Trustee Level:
– More use of metrics and discussion of risks and results of activities
– Presentation of key financial drivers instead of detailed financial
information
– Use of summarized financial reports
– Discussion of liquidity, capital asset acquisitions and financing, and
capital needs
• Changes at the senior central management level:
–
–
–
–
–
More use of metrics of risks’ monitoring and mitigating activities
Divisional results highlighted instead of detailed
Use of Divisional scorecard and metrics
More discussion of liquidity, capital structure
More discussion of capital asset costs and financing
DRAFT
13
Putting It All Together, cont.
• Changes at the divisional management level:
– Use of GAAP to reflect Financial Performance, Capital Structure
and Liquidity on a divisional basis
– Revised Funds Basis Statement of Activities to show
controllable costs vs. allocations, and to show support separate
from revenues
• Other Changes
– Using Natural Class of Expenditures for Funds Reports (or a
matrix of natural class and function)
– Presenting Fund Balances / Net Assets as well as significant
restrictions
– Presenting Capital Asset Acquisitions and Sources of Financing
– Reporting Central Bank (if one) Liquidity and Needs
DRAFT
14
Specific Topical Discussions
• Budgets
• All Funds Reporting / Net Asset Categories
• Financial Operations Reporting
• Management Discussion and Analysis
15
A Word About Budgets
• Budgets are a control process and tool to manage financial affairs
• Trustees are interested in:
–
–
–
–
Ensuring that proper financial controls are in place
Overseeing monitoring and mitigating processes
What happened vs. planned
Whether reserves are sufficient and flexible to cover contingencies
• Significant variances occur for a number of reasons
– Poor planning – either good or bad
– Unanticipated linkages (or not) between events
– Inadequate controls
• Reporting to Trustees needs to focus on why a significant variance
occurred and if internal action is needed to correct process, and
less on the variance itself
DRAFT
16
All Funds Reporting
• Issue is that the board is responsible for all of the funds,
throughout the year, not just at the annual audit
• Most internal reports are driven by the operating budget, may
include a capital budget, and likely has something about cash
flow (post 2008)
• Financial Statement presentation of net asset categories is not
detailed enough to ensure the board and senior non-financial
leadership understand their stewardship responsibilities
17
Public Institution
Net Asset Categories
• Composition of the reporting entity is critical
– Institution
– Component Units
• Net Assets in a GASB set of financial statements:
– Invested in capital assets, net of related debt
– Restricted:
• Non-expendable
• Expendable
– Unrestricted
18
Public Institution
Net Asset Categories
• Sub-categories of Net Assets in a GASB set of financial
statements:
– Net investment in plant
– Restricted –non-expendable by purpose of restriction.
Includes
• Endowment
• Loan permanent funds
– Restricted –Expendable by purpose
•
•
•
•
•
Current
Loans
Unexpended Plant
Debt Service
Unspent payout
– Unrestricted
• Current
• Designated for plant
19
Private Institution
Net Asset Categories
• Unrestricted Net Assets
• Temporarily Restricted Net Assets
• Permanently Restricted Net Assets
Translates into these categories……
20
Private Institution
Net Asset Categories
Unrestricted Net Assets
•
•
•
•
•
•
•
Current Unrestricted Funds
Loan Funds
Quasi – endowment, unrestricted
Unrestricted unexpended plant funds
Renewals and replacements for plant funds
Retirement of indebtedness funds
Net invested in plant funds
Temporarily Restricted Net Assets
• Current Restricted Funds (including sponsor funds, donor funds and unspent gains
from total return program)
• Loan Funds
• Quasi – endowment, restricted
• Term endowment
• Restricted unexpended plant funds
• Contractual renewals and replacement funds
Permanently Restricted Net Assets
• Endowment Funds
• Loan Funds - Revolving
21
Financial Operations
• College has a “balanced budget”
–
–
–
–
Uses its external financial statement format to also report internally
Uses an operating indicator that is fairly industry consistent
High endowment payout rate
Also uses operating gifts to fund current operations
• Does the College have a structural deficit?
– Structural deficit is when recurring revenues are less than recurring
operating expenses
– Financial Statement format may be key communication tool
– Need to highlight differences between revenues and support
• Board members often do not understand differences and nature of
support since they do not exist in for-profit organizations
– Need to communicate dependency on operating contributions and
endowment payout
22
Operating Performance
Normal Format
NORMAL FORMAT
2006
2010
TUITION & FEES, NET
25,200
31,400
AUXILIARY ENTERPRISES
10,900
13,000
CONTRIBUTIONS
4,000
2,200
ENDOWMENT PAYOUT
8,500
7,500
OTHER
4,200
4,600
52,800
58,700
24,200
28,000
5,500
5,800
12,000
13,500
LIBRARY
2,000
2,600
ADMINISTRATION
9,000
11,400
TOTAL EXPENSES
52,700
61,300
100
(2,600)
REVENUES AND SUPPORT:
TOTAL REVENUES & SUPPORT
EXPENSES
INSTRUCTION
STUDENT SERVICES
AUXILIARY ENTERPRISES
NET OPERATING SURPLUS (DEFICIT)
23
Revised Format to Segregate
Support from Revenues
2006
2010
OPERATING REVENUES :
TUITION & FEES, NET
AUXILIARY ENTERPRISES
OTHER
TOTAL REVENUES
25,200
10,900
4,200
40,300
31,400
13,000
4,600
49,000
24,200
5,500
12,000
2,000
9,000
52,700
28,000
5,800
13,500
2,600
11,400
61,300
(12,400)
(12,300)
4,000
8,500
12,500
2,200
7,500
9,700
100
(2,600)
EXPENSES
INSTRUCTION
STUDENT SERVICES
AUXILIARY ENTERPRISES
LIBRARY
ADMINISTRATION
TOTAL EXPENSES
DEFICIT BEFORE SUPPORT
SUPPORT:
CONTRIBUTIONS
ENDOWMENT PAYOUT
SUPPORT
NET OPERATING SURPLUS (DEFICIT)
24
MD&A: A Treatise on Risk
• Public Company Topics (as examples)
– Qualitative and quantitative risks to the Business and changes to those risks
– Revenue recognition and estimates required
– Discussion and highlight of major balance sheet and operating metrics – usually a 5
year schedule with discussion of year over year changes in the past 3.
– Significant factors effecting performance
– Liquidity and Capital Resources
– Working Capital
– Debt
• GASB Reporting Organization Topics
– To provides an objective and easily readable analysis of the unit’s financial activities
– Should include:
•
•
•
•
•
Comparison of current year to prior year
Analysis of overall financial position and results of operations
Analysis if significant changes in funds and budget variances
Describe capital asset and long-term debt activity
Description of currently known facts, decisions or conditions that are expected to have a
significant effect on financial position or operating results
25
MD&A - Liquidity
• Liquidity Ratio
– Sources of Liquidity/Uses of Liquidity
– Two time frames –
• Short-term – generally 30 days
• Intermediate measure – generally 90-120 days
• Longer time frames are not that relevant
– Sources
• Same day or next day assets
• Need to address endowment investments and whether to count these
• Others as described in policy (SFAHE chapter 4)
– Uses
• Operation, debt service, capital
• Others as described in policy (SFAHE chapter 4)
• Importance of establishing policy/criteria to calculate Ratio and
rationale of what is in or out
26
MD&A - Financial Health
• Composite Financial Index
– Measures Overall Financial Health using 4 component ratios and a
scoring /weighting system
• Four Component Ratios
– Primary Reserve - Expendable Net Assets /Total Expenses
– Viability Ratio - Expendable Net Assets /Total Debt
– Net Operating Revenues – Net Revenues from Operations /Total
Unrestricted Operating Revenues
– Return on Net Assets – Change in Total Net Assets/Total Assets
27
Institutional Composite
Financial Index
4 High Level
Questions
Sufficiency and
Flexibility
Live Within our
Means
Sufficient
Return on Net
Assets
Debt Managed
Strategically
4 Ratios
Primary
Reserve
Net Operating
Revenues
Return on Net
Assets
Viability
0.73
4.96%
16.24%
0.94
Composite
Financial Index
(CFI)
Compute CFI
5.05
28
Institutional Graphic
Financial Profile
Primary Reserve
10.00
8.00 5.51
6.00
4.00
2.00
0.00
-2.00
Return on Net Assets
8.12
7.09Net Operating Revenues
-4.00
2.25
Viability
2011
29
Financial Health Reserves
• What are the levels of our financial reserves? How
restrictive?
– Levels and Sources
– Degree of Flexibility
• Institution – President’s discretion
• School – Dean’s discretion
• Department – Chair’s discretion
• Faculty
• Financial Aid – how restrictive?
30
Financial Health Reserves
in $M
BY PURPOSE
Institution Wide
Department
Capital Projects
Financial Aid
General
By Department/Major
By Region
subtotal - Financial Aid
Total
By TYPE
Endowment
Operating/Current
Unexpended Plant
2008
2009
2010
2011
32.8
17.1
2.3
25.1
14.9
2.4
26.0
14.2
1.7
29.1
18.4
8.2
35.0
12.2
4.1
51.3
27.2
8.7
2.5
38.4
28.3
9.0
2.9
40.2
30.0
9.3
3.0
42.3
103.5
80.8
82.1
98.0
97.1
4.3
2.1
103.5
75.2
3.2
2.4
80.8
77.4
3.0
1.7
82.1
86.3
3.5
8.2
98.0
31
MD& A – Example Financial
Drivers
• Some Key Financial Drivers
–
–
–
–
–
–
–
–
Student Headcount
Acceptance & Matriculation rates
Faculty & Staff headcount
Tuition discount rate
Capital expenditures
Endowment Investment balances and overall return
Auxiliary services net margin %
Levels of State support
• Present drivers over an extended time frame
– 5 year historical
– Project into future using budget projections and financial
statement modeling
32
MD&A – Facilities
• Age of Facilities Ratio –accumulated depreciation/depreciation
expense
• Deferred Maintenance Ratio – Outstanding maintenance
requirements /expendable net assets
• Risk in funding capital projects & variability in $ and timing of
gifts
IN $M
COST
DORM
BLDG A
BLDG B
2013
10.0
5.0
15.0
PLANNED FUNDING
DEBT
10.0
EQUITY
2.0
GIFTS
3.0
15.0
2014
5.0
20.0
15.0
40.0
2015
5.0
30.0
35.0
TOTAL
15.0
30.0
45.0
90.0
25.0
2.0
13.0
40.0
25.0
4.0
6.0
35.0
60.0
8.0
22.0
90.0
33
MD&A – Tuition Dependency and
Discount Rate
• Some ratios that portray risk and drivers
– Tuition Dependency Ratio
• Net tuition & fees divided by operating income
– Net Tuition & Fees Contribution Ratio
• Net tuition & fees divided by total expenses
– Total student revenues can be used too
• Net Tuition & Auxiliary Enterprises revenues
– Tuition Discount Rate
• Need to define discount and what are sources of funding the
discount
– Just reduction in gross rate or does it also include financial
aid awards? Which type of awards?
34
Wrap–Up and Questions
Follow up to any topics presented today
35