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Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Introduction to Governmental and
Not-for-Profit Accounting, 7e
Chapter 14: Analysis of
Financial Statements and
Financial Condition
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Introduction
• Financial statements is the Primary source
for analysts:
Credit rating agencies, lenders
• Ratios identify changes, deviations from
normal
– Ratios: derived from financial statement
amounts
• No single ratio is comprehensive
Information Content of Financial Statements:
A Financial Analysis Perspective
1- Statement of net position (balance sheet)-
– Provides information about liquidity, financial
flexibility
• Assets/liabilities classified, in order of liquidity
• Net assets classified according to restrictions
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Information Content of Financial Statements:
A Financial Analysis Perspective
2- The statement of activities (or statement
of operations) may indicate:
– Whether resources covered costs
– Sources of revenues (indication of stability)
– Nature of services provided
– Whether unusual factors influenced operating
results
– Limitation: may appear positive without
reporting unmet service needs
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Information Content of Financial Statements:
A Financial Analysis Perspective
3- Notes:
is considered as an integral part of
financial statements
– Property tax calendar: timing affects amounts
– Debt service requirements, pension plan
obligations
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
An Approach to Financial Statement
and Financial Condition Analysis
• Information analyzed depends on purpose
• The analyst needs to convert data
elements to more useful formats
• Data formats used in financial analysis
include
– Ratios
• Relate one amount to another
– Per capital information
• Divide amounts by population
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
An Approach to Financial Statement
and Financial Condition Analysis
– Common-size statements
• Convert numbers to percentages of 100
– Percentage change information
• Compare current to prior year(s)
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
An Approach to Financial Statement
and Financial Condition Analysis
Analysis Types:
• Time-series analysis
– Evaluate one entity over multiple years
• Comparative analysis
– Compare to another entity/set of entities
– Beware of distortions between different
entities
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators
• Consider financial indicators
– In groups (not just one indicator)
– Over time
– Compared to similar organizations
• Liquidity indicators
– Ability to meet short-term obligations
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - Liquidity
– Current ratio = current assets/current liabilities
• 2 is considered safe
– Quick ratio = (cash + equivalents + short-term
investments)/current liabilities
• 1 is considered safe
• Business-type activities: analysts include accounts
receivable
• Governmentals: analysts exclude (but consider)
taxes receivable
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - Liquidity
• Short-term investments
– CDs, money market, U.S. Treasury bills
• Cash equivalents
– Short-term, liquid investments
– Readily converted to cash
– Original maturity within 3 months
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - Liquidity
– Number of days’ cash on hand =
(cash + equivalents + short-term investments)/
[(total expenses-bad debts-depreciation)/365]
• Often used for NFP hospitals
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial Condition
Analysis Indicators - Efficiency
• Efficiency indicators
– Accounts receivable collection efficiency:
• Days’ revenue in receivables = net patient accounts
receivable/(net patient service revenue/365)
• Property tax collection rate = current-year real
property taxes collected/current year real property
tax levy
– < 95% considered sign of potential distress
• Property tax receivable rate = real property taxes
receivable/real property tax revenues
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial Condition
Analysis Indicators – Efficiency, Solvency
– Total asset turnover = unrestricted revenues,
gains, other support/unrestricted net assets
• Solvency indicators
– Ability to meet recurring expenses + cushion
– Operating margin = excess of revenues over
expenses, expenditures/total revenues, gains,
other support (or other corresponding item)
• OR net change in fund balance/(total revenues +
certain transfers in)
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial Condition
Analysis Indicators - Solvency• General-purpose governments: general fund or
general/debt service/special revenue
• Evaluate for more than 1 year
• Beware of including one-time items
– Budgetary cushion = available fund
balance/total revenues + certain transfers in
• Used for governmentals, 5-10% considered safe
• GFOA recommends General Fund unrestricted
fund balance be no < 2 months of regular general
fund revenues or operating expenditures
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial Condition
Analysis Indicators – Solvency, LT
– Program service ratio =
program expenses/total expenses
• Used for NFPs
• Long-Term (LT) Indicators
– Ability to meet LT debt obligations
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - LT
– General purpose governments
• Debt burden = outstanding LT debt/population (or
full value of taxable real property* or personal
income*)
– Laws limit debt: usually expressed as a
percentage of full value of taxable real property
– *good measures: they consider community
wealth
– Outstanding LT debt includes overlapping debt
» Government’s share of debt issued by other
governmental units
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - LT
– May exclude self-support debt
» Debt paid by government’s enterprise
revenues
• Overall debt (direct + overlapping) > 5% is above
average
• Debt service burden = total debt service/total
revenues (or total expenditures)
– >10% above average
– Ideal payback rate for debt principal: 25% in 5
years, 50% in 10 years
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - LT
– Government enterprises, NFPs
• Focus on leverage: extent of debt
– LT debt to capitalization = LT debt/LT debt +
unrestricted net assets
– LT debt to equity = LT debt/ net assets or
unrestricted net assets
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - LT
• Focus on coverage: ability to repay
– Debt service coverage = [(excess of revenues
over expenses) + depreciation + interest]/
principal payment + interest expense
– Times interest earned = (excess of revenues
over expenses + interest expense)/
interest expense
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Statement and Financial
Condition Analysis Indicators - LT
– Pension and other obligations
• Funded ratio = trust fund assets available for benefits/
benefit obligation (actuarial accrued liability)
– 80% reasonable
• Payout coverage = trust fund assets available for
benefits/ benefits paid last year
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Condition Assessment -
Overview
• Longer time period, broader in scope
• Consider financial statements, economics,
demographics, administration, politics
• Consider an entity’s ability to:• Pay LT debt as it’s due
• Provide services to citizenry
• Maintain activities during economic downturns
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Condition Assessment -
Reasons
• Credit-rating agencies determine credit
worthiness
• Credit enhancers insure debt
– Guarantee debt and decrease interest costs
• Fiscal oversight committees
– Assess to detect signs of stress
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
Financial Condition Assessment –
Other Matters to Consider
• Tax revenue bases
– Tax revenue: primary source of funding
– Increases/decreases to tax bases are critical
• Tax bite = tax revenues/tax base
– Indicates ability to raise taxes
• Economic/demographic trends
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall
• Managerial skill and political will
– Are longer-term financial plans in place?
– Are annual budgets routinely balanced?
– Are capital assets partially financed from tax
revenues?
– Does government have strong expenditure
control and policies regarding budgetary
cushion?
– Does government adequately finance its
pensions?14-*
Financial Condition Assessment –
Other Matters to Consider
Copyright ©2013 Pearson Education, Inc. publishing as Prentice Hall 14-*
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