11-03-2008 (c) 2007 Woods Bowman, all rights reserved 1

Beyond the Bottom Line

Woods Bowman, Ph.D.

December 4, 2008

11-03-2008 (c) 2007 Woods Bowman, all rights reserved 2

Financial health

= Capacity + Sustainability

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Financial Capacity

A cushion of current & potential resources

that allow organizations to adapt & initiate

change.

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Get the balance right

Too little capacity = paralysis

Too much capacity = complacency

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Sustainability

An organization must be able to sustain its capacity over any time period Long run (5 to 10 years) Short run (1 to 5 years) Here-and-now (1 year)

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Overview

Long Run Short Run Here & Now

Capacity Equity Ratio

Months of Spending

Current Ratio

or Cash-to-Expense Ratio

Sustainabilty Return on Assets

Expense Margin

Turnover in

(1) A/R & (2) Payables

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Long-run Capacity

Equity Ratio =Total Net Assets / Total Assets

Should be > 0.5 Medians by asset size (~28,000 in each group):

Small (no more than $201K) = .63 Medium ($201K to $815K) = .76 Large ($815K to $3.26M) = .73 X-Large (over $3.26M) = .68

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Sustaining long-run capacity

Return on Assets (ROA) =Change in Total Net Assets / Average Total Assets

Should by > 3.5 % (inflation) Median ROA by asset size:

Small = 0.6 % Medium = 1.9 % Large = 1.4 % X-Large = 2.3 %

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Short-run capacity (1 to 5 years)

Most planning is done for the short-run More complicated than other cases:

Physical assets & securities are constraining Donor restrictions are constraining

In long-run: There’s time to change things Here-and-now: Few choices; go with what

you’ve got

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Short-run capacity Assume physical & financial investments are

negligible Land Building & Equipment (LBE) + investments

< 10% of total assets, & Investment revenue < 10% of total revenue, & Permanently restricted net assets = 0

I will show how to adjust for these things later

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Short-run capacity (simple)

Months of Spending =12 x Unrestricted Net Assets / Total Expenses

Median number of months by asset size: Small = 2.4 Medium = 5.1 Large = 5.7 X-Large = 7.4

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SustainingShort-run capacity (simple)

Expense Margin =Change in Unrestricted Net Assets / Total Expenses

Median Expense Margin by asset size: Small = 0.6 % Medium = 1.9 % Large = 1.4 % X-Large = 2.3 %

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Short-run capacity (general)

Same “Months of Spending” formulas with Unrestricted Net Assets reduced by

Equity in land, building & equipment Total investments Other assets

Total Expenses are reduced by Depreciation

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Short-run capacity (adjusted)

Median number of months of spending by asset size:

Small = 0.7 (compare to 2.4) Medium = 1.8 (compare to 5.1) Large = 1.7 (compare to 5.7) X-Large = 1.0 (compare to 7.4)

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SustainingShort-run capacity (adjusted)

Same Expense Margin formula with Change in Unrestricted Net Assets reduced by

Change in equity in land, building & equipment Change in restricted net assets All investment revenue

Change in Unrestricted Net Assets increased by Pro forma endowment payout

Subtract Depreciation from Total Expenses

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Sustaining Short-run capacity (adjusted)

Median expense margin by asset size: Small = 0.5 % (compare to 0.6 %) Medium = 3.2 % (compare to 2.2 %) Large = 5.1 % (compare to 2.3 %) X-Large = 12.7 % (compare to 3.1 %)

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Here-&-Now Capacity (liquidity)

Current Ratio is standard= (Unrestricted Cash & Cash Equivalents + Receivables +

Inventory) / Payables & Deferred Revenue

Should be between 1.0 & 5.0 Medians by asset size:

Small = 2.0 Medium = 2.2 Large = 1.2 X-Large = 0.5

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If current liabilities are zero

Cash Expense Ratio= 12 x Unrestricted Cash & Cash Equivalents / (Total Expenses

– Depreciation)

Should be > 1 (one month’s expenses) Medians by asset size:

Small = 1.5 Medium = 2.1 Large = 1.4 X-Large = 0.8

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SustainingAvailable Capacity (numerator)

A/R Turnover =

Accounts receivable / Government grants +

program service revenue Should be < 10 % (~ 1 month’s revenue) Medians by asset size:

Small = 0.0 % Medium = 1.5 % Large = 2.7 % X-Large = 5.8 %

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SustainingAvailable Capacity (denominator)

Payables Turnover =2 x Accounts payable / Total expenses

The denominator should be average non-personnel cash expenses; the 2x factor adjusts for using total expenses instead

Should be < 10 % (~ 1 month’s expense) Medians by asset size:

Small = 0.0 % Medium = 2.7 % Large = 5.0 % X-Large =10.9 %

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In sum

Without financial goals, drift is inevitable Set goals in terms of a range of acceptable

capacity (comfort zone) Have long-term, short-term, and liquidity

goals (maybe more than one each) Let sustainability metrics be whatever is

necessary to stay within comfort zone Start today

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THE END