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A comprehensive analysis of the financial condition of the organization is required in order to determine if an institution is in financial exigency.
This must entail much more than a simple cash flow projection for the next few months. Though cash flows are certainly important, the conclusion of financial exigency is a major condition affecting the lives of numerous people. It must be made with care.
Numerous metrics are described below, and all of them need the data that are reported on the June 30, 2008 financial statements in addition to data going back at least three years (preferably five years). There is no way that a claim of financial exigency can be credible without a thorough examination of these data. It certainly is appropriate to project what these ratios would be going forward. Still, in order to make reliable estimates of the future, all prior years must be included.
The analysis that one should perform in order to make such a claim entails three levels of data examination, described below:
Moody’s uses three variables, then puts various weights on those variables, and comes up with a composite score for an institution. The ratios are all derived from the main components of the Statement of Net Assets and the Statement of Activities. The ratios are described below.
The three ratios are:
The definitions of the components of those ratios are:
A composite score is compiled, and below are the numbers assigned to each variable. A score of 5 indicates the highest degree of fiscal strength in each category.
This is an index that is akin to a bankruptcy prediction model in the corporate world. For nonprofit organizations, a recent study examined several thousand nonprofit financial statements, and determined which variables are most important in predicting financial trouble. Then, a score is created that will yield a rating based on these variables. This score is called the financial vulnerability index, or FVI.
Metrics Utilized:
The FVI should be examined for at least the current year and three years prior; in this manner, trends and specific areas of vulnerability can be discussed. An FVI that is high does not automatically indicate financial exigency; it raises issues that need to be examined. For example, if the surplus margin has turned negative, why did this occur? Are there specific items that were temporary in nature, and not likely to recur, that caused this? Alternatively, is there a pattern or structural issue that needs to be addressed?
In order to ensure that cash flows are being considered, it is also important to examine whether an organization has sufficient cash resources to meet its debt service obligations. This is done through a debt-to-cash flow analysis.
The numerator is interest-bearing debt.
The denominator is what is called EBITDA, or earnings before interest, taxes, depreciation, and amortization. It is a measure of cash flows, as it takes net income and adds back the major non-cash expenses.
This analysis should be done over time, as well as for current and future periods.
All statistics are a tool to be used in making decisions; they do not provide definitive conclusions. The entire picture needs to be analyzed, with consideration of how financial performance has moved over time.