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Nonprofit Financial Analysis Exercise
- 1. Nonprofit Financial Analysis Exercise David H. Gehm Background: For the unnamed organization, we are in receipt of audited financial statements of financial position and activity for the years 2004 through 2009 with a fiscal year-end of June 30th . The organization also included a 2010 budget of their statement of activity. Indicators that this is a social service organization are that the earned income is primarily derived from government contracts and a portion of the organization’s contributed revenue comes from the United Way. Financial Analysis: The statement of financial position shows us the organization’s liquidity, capital structure, amount of temporarily restricted funds and permanently restricted funds, and the short-term and long-term receivable balances. The organization had very little to no working capital. In 2004 it had $164M of working capital and in 2007 had $5.3MM only because it took on a long-term debt of $8.5MM. In 2009 the organization had working capital of almost negative $3.9MM. The current ratio further illustrates the working capital shortage. A financially healthy organization typically has a current ratio of 2:1 (i.e. $2 of assets for every $1 of liability) or better. In 2004 it had a current ratio of 1.16:1. In 2007 the current ratio was 3.59:1; again due to the large lending facility it took on. In 2009 the current ratio dropped to .08:1. This organization has very low liquidity and desperately needs cash to be able to pay bills and other liabilities. The balance of the receivables explains part of the liquidity issue. The current year grants and pledges receivable was low relative to the total receivables for the years 2004-2006 and fell to $0 for the years 2007-2009. The majority of the receivables are longer than a year giving the organization no assets to turn into cash to cover current liabilities. In 2009 there was a significant decrease in the investment portfolio. Although it had unrealized net losses of $1,253M and realized net losses of $693M, the consequential change, significantly weakening the organization’s financial standing, was due to releasing $2.3MM from the temporarily restricted assets and transferring it to net fixed assets, increasing net fixed assets by 40% over the previous year. From 2004-2009 net fixed assets increased 12x. How much of the $12MM is property rather than other fixed assets and how do these fixed assets relate to the operation of the organization’s program and mission? Finally, for the statement of the financial position, we look at the net assets and how much autonomy the organization has over the use of those funds. A financially healthy organization typically has 30% or less in permanently restricted assets. The organization has only $729M in permanently restricted assets, which is less than 6% of the net assets. In 2007-2009 $9MM was restricted by a board designation during the same period that they took on an $8.5MM lending facility and presumably was used to collateralize the lending facility which affects their use of their net assets significantly. The statement of activities further shows how much of the revenue is generated from contributions rather than earned. In 2005 the contributed revenue accounted for 21.8% and in 2009 24.6% of overall revenue. Contributed income is typically expected to be 75% - 80%, inverse of what is seen with this organization. Over a third of the operating revenue is generated from government contracts. This is
- 2. possibly problematic if government policies change resulting in reduced spending in the future. The revenue from trustees and individuals is also notable with only a little over 10% being generated in this category. A large donor pool offers a more stable revenue source and the risk of individual donors limiting future gifts are mitigated. The expenses are expressed functionally and shown as personnel (salary and salary related expenses), professional fees, occupancy, and support. Typically, the expenses will be further attributed to program, management, and fundraising and we will need a copy of their Form 990 tax return for that information. Since 2004, personnel expenses decreased from 70.5% to 64.5%, professional fees remain relatively steady around 14%, support also remained steady around 9%, and occupancy increased from 6% to almost 12%. The 2010 budget projects a decrease in revenue from government contracts and program services by over 7% and 11% respectively. The organization’s projection of revenue from foundations, corporations, and the United Way increases 184%. The projected expenses for 2010 are expected to decrease, personnel expenses and professional fees are reduced by 27% each, support is lowered by over 34% and occupancy is lowered by almost 54%. We need additional information about these projections to understand how the organization will increase revenue $600M when there are significant decreases to the personnel expenses and fundraising expenses. Observations/Concerns: The organization is insolvent. It has approximately $300M in cash and equivalents to cover over $4.2MM in current liabilities. It has no receivables assets that can be turned into cash for the short-term. All of the grants and pledges receivable are considered non-current. Are these receivables still collectible? The organization has approximately $4.6MM in liquid net assets that can convert into cash, but that would further harm their long-term financial position. The organization took on an $8.5MM lending facility in 2007 although the interest expense doesn’t start until 2010. Was the interest capitalized until the capital improvement project was completed? More importantly, how is the facility structured and is any part of it a line of credit that can be used to cover short-term cash flow? What are the covenants for this lending facility, how much of their investment portfolio was used to guarantee the lending facility, and how much of the investment portfolio can the organization utilize or even liquidate for short term cash? What assets can be used to service the debt obligation? In 2009 net fixed assets account for almost 50% of the total assets. Are the fixed assets primarily comprised of property and how do they fit into the execution of the organization’s programs? What benefit will the organization gain with the transfer of $2.3MM of the investment portfolio to fixed assets resulting in a significant weakening of the financial position for this capital expenditure? The revenue from trustees and individuals on the statement of activities is particularly noteworthy with only a little over 10% being generated in this category. Who are the trustee members? Are they acting in an advisory capacity or are they persons of wealth who might be in a position to contribute needed funds? Can more be generated from individual donors too? As noted above, how will the organization increase contributed revenue by the projected $600M when expenses for personnel are decreased by almost $1.8MM and fundraising by another $330M?
- 3. On the statement of activity in the Unrestricted Operating Revenue category the figures for net assets released from restrictions for 2008 and 2009 do not match the temporarily restricted assets released under the Unrestricted Operating Expense category for the same period when every other year matches. Additional Supporting Material: Additional financial documents are needed to better understand the financial standing of this organization. We would like to see a full set of the financial statements including the footnotes, and the auditor’s opinion letter to see if there are any qualifications or adverse remarks as to the presentation of the financial statements. A cash flow forecast, and the Form 990 tax return would be extremely useful. Summary: In the short-term, the organization needs cash and/or a line of credit to help cover current liabilities. To ascertain if any financial aid for the organization’s cash flow is practical, the grants and pledges need to be reviewed to determine their collectability. Longer term, the organization needs a comprehensive plan to raise unrestricted funds and reduce debt.