Financial statement analysis for private colleges and universities.

The terms "synthesis" and "analysis" are opposite in meaning, but they are often used incorrectly, sometimes interchangeably, in current English usage. In their simplest definitions, to synthesize is to put things together and to analyze is to take things apart. We are familiar with the terms "qualitative analysis" and "quantitative analysis" employed in chemistry. The former is used to identify the components of a substance, while the latter is designed to determine the amounts or proportions of the substance.

There is an almost complete analogy between scientific analysis and financial analysis. Financial analysis separates financial statements into their component parts in order for those parts to be examined. The end result of this examination is to provide information from which conclusions can be drawn in order to make managerial and financial decisions. The many users of financial statements have specific informational needs, and these needs can only be met through financial statement analysis.

Techniques for analyzing the financial statements of commercial enterprises are well established. This is not the case for non-profit entities such as colleges and universities, charities, hospitals and other non-business organizations. John Minter and Minter Associates have done some excellent work in this area. They created a data base of a national sample of institutions of higher education using audited financial statements. However, something more specialized is needed for private liberal arts colleges and universities. The purpose of this article is to respond to that need.

Fund Accounting

One reason for this disparity is the different accounting methods employed by commercial companies and academic institutions. A major goal of business entities is to earn a profit and accounting systems are designed to provide information about income earning activities and results. Of course, financial statement analysis is primarily concerned with profit making potential and future cash flows.

Conversely, goals of private colleges and universities do not include earning profits. Their goals are stewardship of the resources committed to them and the accomplishment of educational objectives. Therefore, these institutions utilize fund accounting, which focuses on the source of financial resources and how they have been used to accomplish stated objectives.

Since these entities are not profit seeking, the demand for financial statement analysis has been less pronounced than for profit-making organizations. However, a strong case can be made that private colleges and universities can benefit greatly from financial statement analysis. This article presents the practicality of ratio analysis for this group of non-profit organizations.

The Financial Statements

Private colleges and universities report their financial activities in accordance with Audits of Colleges and Universities published by the American Institute of Certified Public Accountants. The financial statements are a Balance Sheet, a Statement of Changes in Fund Balances and a Statement of Current Funds Revenues, Expenditures and Other Changes. The usefulness of these statements can be greatly enhanced by employing ratio analysis similar to that which is available to commercial companies.

A fair question is, "Why concentrate on private colleges and universities?" Unlike public universities, private institutions are hindered in their efforts to utilize ratio analysis because of differences in their accounting techniques and financial practices. They are not required to conform to particular accounting procedures, such as those required by their respective states or commissions of higher education. For this reason, financial comparisons are often meaningless.

It is often overlooked that financial ratios are completely ineffective unless compared to something, such as the ratios for the previous year or those of similar institutions. Business entities can compare their financial ratios with similar organizations by using industry averages provided by Dun & Bradstreet, but there are no such averages for private institutions of higher learning.

What is needed is a financial ratio model that makes possible valid ratio analysis for private colleges and universities and that allows meaningful comparisons among these institutions. The remainder of this article is the illustration of such a model.

The Model

Ratio analysis should answer these four fundamental questions:

1. Is the institution financially healthy as of the balance sheet date?

2. Is the institution financially better off at the end of the year than it was at the beginning of the year?

3. Did the institution live within its means during the year?

4. What policies and practices should the administration change to achieve the needed improvements in financial results?

The first step in constructing a financial ratio model is to determine a standard set of financial statement values to be included in the analysis. This is a challenging but necessary task. Categories of expenditures and revenues are not uniform among institutions. For example, one institution might include athletics with academic affairs while another may place it with student development. Similarly, an expense item might be in the instructional budget of one university but included in student services or administration in another. Therefore, it is necessary to provide standard definitions of financial statement accounts in order for financial statement analysis to be meaningful and comparable. The first step in designing the financial ratio model was the development of a data dictionary. The data dictionary (see page 43) is peculiar to private colleges and universities. Thirty-seven definitions of accounts and groups of accounts are included.

Gathering The Data

The data dictionary provides the foundation for identifying the data to be analyzed from the institutions' financial statements. There is a similarity and commonality of purpose among private colleges and universities, and therefore their financial statements are somewhat, but not completely, similar. The value of the data dictionary is that financial ratios based upon the definitions will make comparability among the the institutions possible even though they are not completely alike.

An electronic spreadsheet program, such as Lotus 1-2-3, Quattro-Pro or Microsoft Excel, is the ideal vehicle in which to compile the data from the financial statements. The process is simple. The items from the left side of the data dictionary are listed in the left column of the spreadsheet, and the corresponding amounts from the financial statements are placed in the columns to the right. Financial analysis is enhanced when more than one year is examined. Therefore, as many columns are used as the number of years the administration wishes to analyze. In business organizations, five-year analyses are often presented. This allows both comparison between years and the recognition of trends.

When this process is complete, the data are ready for analysis. Fifty-eight ratios have been developed for analyzing the financial statements of private colleges and universities (see page 44). Once the data are placed in the spreadsheets, calculation of the ratios can be accomplished. The formulas are placed in the spreadsheet and the ratios are computed.

Discussion of Ratio Analysis

By any measurement, 58 ratios represent a lot of number crunching. Most textbooks on financial accounting present from 15 to 20. Dun & Bradstreet provides 14 key business ratios for 125 lines of business. Of course, these are for commercial enterprises, and we can not escape the conclusion that private institutions of higher education are different, with different problems and goals. Financial statement analysis can aid in solving those problems and accomplishing those goals, but a specialized set of ratios is required, one that is specifically designed for this type of organization. It so happens that the required specialized set of ratios contains 58 formulas.

Five private colleges and universities participated in the development of the financial analysis model. A panel of experts, consisting of the researcher and the controllers of the five institutions, through much discussion and negotiation, developed the data dictionary and accurately classified the data according to its categories.

The next step was to place the needed amounts from the institutions' financial statements into a data spreadsheet for the past five years. Such a spreadsheet was prepared for each institution on a 3.5[feet] computer disk, and the values defined in the data dictionary were entered in it. Another spreadsheet was prepared containing the 58 formulas. Its purpose was to receive information from the data spreadsheet and compute the ratios from them. Thus the five controllers were able to analyze the financial statements of their institutions for the past five years, which was a major accomplishment.

The potential for study and comparison is enormous. It is well recognized that single ratios have value only when compared to something else. Three types of analysis are possible: from year to year within each institution, comparison of actual ratios with budgeted ratios and comparability among similar institutions.

If the administration of a private college or university would like to analyze its own financial statements but finds the computation of 58 ratios daunting, it would be possible to pick and choose among the list to identify those ratios that are deemed most useful. However, it would lose one of the major benefits of its efforts: the opportunity of comparison with similar institutions. Therefore, the authors recommend using the entire package for maximum utility.

Availability of Additional Information

For readers who desire more information about this subject, including the ratio analysis of the five schools referred to in this article, the complete research project is available from the following address. There is a choice of both soft cover and hard cover.

University Microfilms International 300 North Zeeb Road P.O. Box 1764 Ann Arbor MI 48106 1-[phone] Order No: AAC 9410924 Title: Ratio Analysis: A Model for Private Liberal Arts Colleges and Universities

Note: Lotus 1-2-3 is a trademark of Lotus Development Corporation. QuattroPro is a trademark of Borland International. Microsoft Excel is a trademark of Microsoft Corporation.

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Arnold Cirtin; MBA, PhD, is professor of accounting at Ball State University in Muncie, Indiana.

Connie Lightfoot, MA, EdD, is an instructor of computer information systems at Ivy Tech State College in Marion, Indiana.