Financial Statement Analysis For Colleges And Universities

Author(s): Charles J. Woelfel

Source: Journal of Education Finance , Summer 1987, Vol. 13, No. 1 (Summer 1987), pp.
86-98
Published by: University of Illinois Press

Stable URL: https://www.jstor.org/stable/40703586

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JOURNAL OF EDUCATION FINANCE
12 (summer, 1987), 86-98

Financial Statement Analysis For

Colleges And Universities
Charles J. Woelfel

Administrators
versities must beand
ablegoverning boards
to understand and of collegesextensive
interpret and uni-
financial information that can assist them in carrying out their
planning, evaluating, and controlling responsibilities. These re-
sponsibilities relate primarily to making rational decisions about
the allocation of institutional resources, the delivery of services to
various constituencies, and the evaluation of performance as they
impact on the goals and objectives of the institution. Because of
the complexities of financial reporting, it is appropriate that a
conceptual framework be provided that will assist these individu-
als and groups in assessing their fiduciary commitments.
Accountants, financial officers, and administrators of institu-
tions of higher education have developed significant analytical
tools for evaluating the financial condition and operating perfor-
mance of for-profit enterprises. Most of these tools and tech-
niques are applicable to nonprofit institutions, such as state
owned and private colleges and universities.
One such tool is ratio analysis of financial statements. With
the use of ratio analysis, financial and operational concerns as
well as variances from institutional plans and policies can be iden-
tified. This article explains and illustrates specific financial state-
ment ratios that are useful in analyzing and interpreting the fi-
nancial statements of nonprofit institutions of higher education.
An introduction to college and university accounting practices is
also presented as a background for financial statement analysis.

Authoritative Literature

In the United States, the Financial Account

Board (FASB) is the major nongovernmental aut
associated with the establishment of generally acc
ing principles. In 1979, the FASB assumed respo
counting and reporting standards for colleges a
with the issuance of FASB Statement No. 32, "

CharlesJ. Woelfel is Professor of Accounting, University of North Caroli

[86]

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 1987] Financial Statement Analysis 87

counting and Reporting Principles and Practices in AI

ments of Position and Guides on Accounting and Aud
ters." FASB Statement No. 32 established the American Institute
of Certified Public Accountants' (AICPA) industry audit guide,
Audit of Colleges and Universities (1973), as its source of preferable
accounting principles. The guide, along with Statement of Posi-
tion 74-8, "Financial Accounting and Reporting by Colleges and
Universities," provides the basis for generally accepted account-
ing principles for colleges and universities. Most of the principles
and practices described in the AICPA pronouncements were
adapted from College and University Business Administration
(CUBA), a two-volume accounting manual prepared by the Na-
tional Association of College and University Business Officers in
1952 and subsequently revised.
Objectives of Financial Reporting
The major groups interested in information provided by fi-
nancial reporting of colleges and universities include the follow-
ing:

1. Resource providers Taxpayers, contributors, lenders,

suppliers, and others
2. Constituents Persons and groups who use and
benefit from services provided by
the institution

3. Governing and Persons responsible for establishing

oversight bodies policy and for overseeing and
appraising the administration
4. Administrators Individuals responsible for carrying
out the policies mandated by
governing bodies and directing
the day-to-day operations of the
institution

Financial accounting and reporting are directed primarily at

providing a basis for decision-making. The objectives of financial
reporting for colleges and universities focus on:

a. Who will use the information provided by financial re-

ports?
b. What are the basic interests or concerns of the users?
c. What types of decisions do these users make?
d. What type of information do the users need to assist
them in reaching decisions?
e. What information can financial reporting provide to
meet these informational needs?

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88 Journal of Education Finance [Vol. 13

Financial reporting for colleges and universities is g

acknowledged to include the following broad objective

1 . To provide information useful in making resource

cation decisions
2. To provide information useful in assessing services and
the ability to continue to provide services
3. To provide information useful in assessing manage-
ment's stewardship and performance, especially service
efforts and accomplishments
4. To provide information about the institution's
economic resources, obligations, net resources, and
changes in them, especially (a) the nature of and rela-
tion between inflows and outflows of resources during
a period, (b) the distinction between resource flows that
are related to operations and those that are not, and (c)
how the institution obtains and spends cash, and other
liquidity issues.

Fund Accounting

The focus of college and university accounting is o

the sources of resources and how those resources have been
utilized in meeting educational objectives. Fund accounting is
ployed to attain the accounting objectives of colleges and univ
sities. The National Council on Governmental Accounting
fined a fund as

... a fiscal and accounting entity with a self-balancing set

of accounts recording cash and other financial resources
together with all related liabilities, and residual entities or
balances and changes therein, which are segregated for
the purpose of carrying on specific activities or attaining
certain objectives in accordance with special regulations,
restrictions, or limitations.

Six fund groups are used in accounting and reporting systems

of colleges and universities. The groups are also divided into sub-
groups as needed for planning, controlling, decision making, and
reporting purposes. Fund groups are defined by the purposes of
the funds or by restrictions placed on them. The fund structure
of colleges and universities includes the following:

Fund Groups Subdivisions

1 . current funds current funds - unrestricted
current funds - restricted
2. loan funds endowment funds

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1987] Financial Statement Analysis 89

3. endowment and related term endowment funds

funds quasi-endowment funds
4. annuity and life income annuity funds
funds life income funds
5. plant funds unexpended plant funds
funds for renewals and
replacements
funds for retirement of
indebtedness
investment in plant
6. agency funds

College and university accounting and reporting is concerned

primarily with the measurement and reporting of revenues and
expenditures (not expenses) - fund flows and fund balances. The
determination of net income from operations is not a considera-
tion because colleges and universities are not-for-profit entities.
In college and university accounting, revenues are classified
by source (e.g., tuition and fees, federal grants) and expenditures
are classified by function (e.g., instruction, research, service) for
external reporting purposes. Expenditures are classified by de-
partment and objective for internal and control purposes.

Financial Statements

Financial statements are summaries of the financial- related

activities of an entity. The basic financial statements prepared by
colleges and universities include the following reports:

1. Balance sheet - a statement of assets, liabilities, and

fund balance.
2. Statement of changes in fund balances - a statement
that describes the activities that result in changes in the
balance of each fund during the reporting period.
3. Statement of current funds revenues, expenditures,
and other changes - a statement that reports on the ac-
tivities of the current funds.

Financial Statement Analysis

Financial statement analysis is a process whic

and current financial data for the purpose of e
mance and estimating future risks and potentials
and techniques are applied to financial statements
to determine measurements and relationships tha
decision making.

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90 Journal of Education Finance [Vol. 13

Financial statement analysis requires the user to poss

following capabilities:

1 . An understanding of financial statements and the g

erally accepted accounting principles which under
these statements;
2. Knowledge of the principles and practices of finan
management; and
3. The ability to apply analytical tools of financial st
ment analysis and to interpret the results of their ap
cation.

The basic tools and techniques of financial statement analysis

include the following:

1 . Ratio analysis A ratio is the proportionate

relationship between two
numbers. The trend of a ratio
is the direction reflected by
changes in the ratio over time
periods.
2. Comparative financial Comparative financial
statements statements present financial
information for the current
and one or more past periods;
they facilitate comparisons for
several reporting periods.
3. Horizontal analysis Horizontal analysis describes
the changes in the same item
(cash, tuition) appearing on a
statement over time. Each item
on a row for one fiscal period
is compared with the same
item in a different period.
4. Vertical analysis Vertical analysis refers to the
conversion of items appearing
in statement columns into per-
centages of a base figure, thus
emphasizing the significance
of the item to the base.

Objectives of Financial Statement Analysis

For Colleges and Universities

Financial statement analysis can be used to assess t

formance and current position of an institution as w
ture potential and the related risks. The fundamenta

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 1987] Financial Statement Analysis 91

which users of the financial statements of colleges an

require information include the following:

1. Is the institution financially sound at the re

date?
2. Has the institution maintained or improved its financial
position during the reporting period?
3. Is information available for assessing services and the
ability of the institution to continue providing services?
4. Are there any major changes in trends, amounts, or
relationships that should be investigated? Are these
changes favorable or unfavorable for the future pro-
spects of the institution?
5. Has the administration discharged its stewardship and
performance responsibilities satisfactorily?

It should be recognized that financial reporting is only one

source of information available to decision makers. Analysis
which relies solely on such a data base is limited. Social, economic,
and political information from other sources is often required to
produce relevant and reliable evaluations and decisions.

Ratio Analysis

Ratios are useful tools for expressing important fi

lationships between items in financial statements. To
ratio must express a relationship that is significant,
condition, or symptom. Ratios provide evidence of an
condition. They can suggest a need for further inq
underlying data or condition.
Ratios are difficult to interpret. To be useful, rati
compared with some standard. Standards that can
colleges and universities include the following:

1. The budgeted ratio for the period being analy

2. The ratio during the preceding period(s) for t
institution;
3. The corresponding ratio for a competitor or similar
institution; and
4. The average ratio for a group of colleges and univer-
sities.

When using and interpreting ratios, one needs to know (1)

when an institution's ratios are significantly different from the
norms reflected for colleges and universities in general, and (2)
the preferable ratios to select for purposes of analysis. Statistical
tools are available to use in evaluating whether differences be-

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92 Journal of Education Finance [Vol. 13

tween an institution's ratios and selected standards are stati

significant. Correlation studies of financial ratios can be
determine the extent of the overlap of various ratios. A dis
of these procedures is beyond the scope of this article.
Ratios that are especially useful in evaluating colleges and
versities can be broadly classified as (1) balance sheet rat
operating ratios, (3) contribution ratios, and (4) allocation
Balance sheet ratios summarize some aspect of financial p
at a particular date, Le., the date on which the balance sh
prepared. Balance sheet ratios are usually more applicable
vate colleges and universities than to state owned and op
institutions. The other ratios summarize some aspect of
tions for a period of time, usually a year. Each of these
classifications will now be discussed.

Balance Sheet Ratios

The balance sheets of the various funds report

condition of the funds on a specific date. A balance
pared for each fund to disclose its assets, liabili
balance, except for agency funds which do not h
ance.

The funds of colleges and universities can

three major categories for purposes of analyzing
tion as determined from balance sheet relations

1. Expendable funds (including restricted a

tricted):
Current funds (A)
Quasi- endowment funds (A)
Unexpended plant funds (A)
Funds for renewal and replacement
Funds for retirement of indebtedness (A)
2. Nonexpendable (or Capital) funds:
Loan funds (C)
Endowment and term endowment funds (C)
Annuity and life income funds (C)
3. Funds invested in plant (B)

A statement of current funds revenues, expenditures, and

other changes is shown in Table 1. This statement will also be
used in describing various ratios. The letters and Roman numer-
als in the list above and in Table 1 are used to facilitate the prep-
aration of various financial ratios discussed in this article.
Five basic balance- sheet ratios can be used to provide infor-
mation concerning the financial health of the institution. A for-
mula for each ratio along with its interpretation is shown in Table 2.

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 1987] Financial Statement Analysis 93
table l
Statement of Current Funds Revenues, Expenditures, and Other Changes

Revenues
Tuition and fees

Federal grants and contracts

State grants and contracts
Private gifts, grants, and contracts
Endowment income
Sales and services of educational activities

Sales and services of auxiliary enterprises (VI)

Expired term endowment
Other sources (if any)
Total current revenues (I)
Less: sales and services of auxiliary enterprises
Educational and general revenues (IV)
Expenditures and Mandatory Transfers
Educational and general
Instruction
Research
Public service

Academic support
Student services

Institutional support
Operation and maintenance of plant
Scholarships and fellowships
Educational and general expenditures
Mandatory transfers for
Principal and interest
Renewals and replacements
Loan funding matching grants
Total educational and general (V)
Auxiliary enterprises
Expenditures
Mandatory transfers for
Principal and interest
Renewals and replacements
Total auxiliary enterprises (VII)
Total expenditures and mandatory transfers (II)
Other Transfers and Additions (Deductions)
Excess of restricted receipts over transfers to revenues
Refunded to grantors
Unrestricted gifts allocated to other funds
Portion of quasi- endowment gains appropriated
New increase in fund balances

Source: College and University Business Administration, Part 5, (Washington, DC: National
Association of College and University Business Officers).

Operating Ratios

Operating or performance ratios relate exclusively t

funds and help analyze the results of operations. Oper
indicate whether the institution has lived within its m
the period. A 1 : 1 relationship can be interpreted a
even point for current operations. Four operating

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94 Journal of Education Finance [Vol. 13
TABLE 2
Balance Sheet Ratios

Ratio Formula Interpretation

1 . Financial position Expendable fund balan

Debt outstanding funds to meet related plant
related to the financing of debt arising from
plant assests (B) investment in plant
2. Plant equity to Net investment in plant Ability of the institution to
plant debt Plant debt whose assets are borrow
invested in plant (B)

3. Expendable fund Expendable fund balances (A) The margin of safety the
Total current funds institution has related to
expenditures and mandatory funds expendable fo
transfers (II) everyday operations
4. Capital Funds Nonexpendable funds Capital funds that may
balances
Total current funds point for other purposes
expenditures and mandatory
transfers

5. Current ratio Current funds assets The ability to pay current

Current funds obligations funds obligations as mature

shown in Table 3 along with the formulas used in their computa-

tion and an interpretation of the meaning of the ratio.
Contribution Ratios

Contribution ratios relate sources of revenue to educational

and general expenditures. These ratios identify the structure of
TABLE 3
Operating Ratios

Ratio Formula Interpretation

1 . Net total revenues Net total revenues (I- II) Did the institution operate
as percent of total Total revenues (I) at a surplus or deficit for
revenues the period?
2. Net educational and Net educa
general revenues as revenue (IV-V)

percent of total Total education and gene

educational and revenue (IV) sufficient to cover the
general revenues expenditures for these
functions?

3. User-based charges Tuition and fees (III) Are user-based

as percent of related Total expenditures and expenditures and transfers
expenditures and mandatory transfers (II) covered by user-based
transfers charges?
4. Net auxiliary Net auxiliary enterprise Are revenues supporting
enterprise resources revenues (VI-VII)

as percent of total Total auxiliary enterpris

auxiliary revenues (VI) those services?
enterprise revenues

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 1987] Financial Statement Analysis 95
TABLE 4
Contribution Ratios

Ratio Formula Interpretation

1 . Operating inflows Tuition and fees or Federal The relation of major

government or State sources of revenue to the
government or Private gifts, total educational and
grants and contracts or general expenditures and
Endowment income or Local mandatory transfers.
government revenues

Total educational and general given

expenditures and mandatory basis, t
transfers (II) sources of revenue.

2. Nonoperating inflows Loan funds or Endowment Percentag

funds or Annuity funds or nonoperating infl
Plant funds

Total nonoperating inflows

operating revenue. Contribut

along with the formulas used in
pretation of their meaning.

Allocation Ratios

Allocation ratios relate major expenditure categorie

cational and general expenditures and mandatory t
cation ratios indicate the structure of operating
Current fund expenditures include all expenses e
tion and expenditures for renewals and replace
and equipment. Current fund expenditures are bro
as educational and general expenditures and e
auxiliary enterprises. Tranfers refer to the movem
fund resources to other fund groups as directed by
board and as required by external agreements. A
are shown in Table 5.

TABLE 5
Allocation Ratios

Formula Interpretation

Instruction or Research or Public Relation of majo

service or Academic support or total education a
Student support or Operation and mandatory tran
maintenance of plant or Scholarships structure of m
and fellowships

Total educational and general its resources am

expenditures and mandatory When compar
transfers (II) basis, they reflect shifts in expenditures.

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96 Journal of Education Finance [Vol. 13
Limitations of Ratios

Ratio analysis has limitations which must be k

when the process is being undertaken. Major limitati
analysis include these:

1. Ratios reflect average conditions that repres

conditions and circumstances.
2. Ratios typically do not reflect price-level effects - the
impact of inflation or deflation - or current market
value.
3. Ratios are constrained by the limitations of the financial
statement data upon which they are based.
4. Comparisons of colleges and universities which have
different operating characteristics, sizes, locations,
methods of financing, etc., may not be relevant.

Attempts to combine the information in several financial

ratios into a single index using multivariate models have met with
mixed results. Difficulties associated with these models result
partly from (1) having to decide which variables (ratios) should
be included and (2) what weights should be applied to the vari-
ables.

In spite of its limitations, ratio analysis is an important tech-

nique for financial statement analysis because ratios reflect funda-
mental relationships that exist in an institution. Ratio analysis can
identify problems and opportunities that are not readily observa-
ble from the financial statements.

Analysis of Separate Funds

It is useful to classify the various funds of colleges an

sities on a basis of primary purpose: current operations
responsibilities; or acquisition of and accountability for
plant, and equipment and related long-term debt. Such
cation follows:

Primary purpose Fund

1 . Finance current operations Current funds
2. Fiduciary responsibilities Loan
Endowments
Annuity
Life income
3. Acquisition of and accountability Plant
for property, plant, and equipment
and related long-term debt

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1987] Financial Statement Analysis 97

When this classification scheme is used for analysi

provided focus on the underlying reason(s) for which
funds were established. Vertical, horizontal, and r
based on primary purpose should disclose how th
employed its assets and liabilities for attaining specif
in accordance with imposed regulations, restriction
tions. This analysis highlights the stewardship fun
sponsibilities of the governing and oversight bodies
trators.

Nonquantitative Data and Information

Nonquantitative information can be used to support or v
date quantitative data produced by financial statement anal
Information relating to the operations, policies, competitive p
ition, quality of administration, and similar matters can be
tremely useful in evaluating a college or university.
Nondollar, quantitative data that can be used to evaluate
efficiency and effectiveness of a college or university include
are not limited to, the following:

• the number of degrees granted

• the number of student credit hours generated
• the number of full time equivalent faculty members
• the relation between admissions and applications
• the progress towards accreditation and other recogni-
tions granted to the institution
• student/faculty ratio

The Going-Concern Problem

Many private colleges and universities are in

jeopardy. The going-concern problem is a reality wh
identified as early as possible so that appropriate a
taken. Most going-concern problems of colleges and
relate to either or both of the following conditions:

1. Financial problems: illiquidity, funds shortag

tinuing operating deficits, debt default, etc.
2. Operating problems: unclear vision of missi
adequate control over operations, competition,
product market demand, etc.

The governing and oversight bodies, administrators

ants, and auditors should establish an early warning s
alerts the institution to a deteriorating situation an

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98 Journal of Education Finance [Vol. 13

propriate, enables the administration and others to

adequate defenses. Turning points in trends, amounts,
lationships identified by financial statement analysis can
early warnings.

Conclusion

Ratio analysis alone cannot provide a complete un

of all the forces impacting on an institution as compl
or university. However, financial statement analys
as a screening, forecasting, diagnostic, and evaluative
ministration and governance. Financial statement
provide a basis for systematic judgments of prima
matters. The four categories of financial ratios dis
chapter (balance sheet, operating, contribution, a
ratios) provide the basis for a comprehensive and int
of institutions of higher education. The importanc
statement analysis should not be underestimated.

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