Goal 5: Develop, enhance, and align business processes
- KPI 5.1: Composite Financial Index
The Composite Financial Index paints a composite picture of the financial health of the institution at a point in time. The Index is built with the values of its four component ratios:
- Primary Reserve – a measure of the level of financial flexibility
- Viability – a measure of the organization's ability to cover debt with available resources
- Return on Net Assets – a measure of overall asset return and performance
- Net Income Ratio – a measure of the operating performance
Once each of the four ratios is calculated, there is an additional process measuring the relative strength of the score and its importance in the mix of creating a composite score. This results in the production of one weighted score for each indicator and when added together the result is the Composite Financial Index. The strength factors and CFI score are standardized scores that fall along a scale of -4 to 10.
A CFI score of 3 is the threshold of institutional financial health.
- The Primary Reserve Ratio, representing 35 percent of the CFI, measures an institution’s financial health by comparing accumulated reserves to annual operating demands. It is calculated by dividing expendable resources at the end of a period by the operating expenses incurred during that period. Expendable resources are those representing financial net assets or the institution’s financial equity. Excluding physical assets such as buildings and equipment (and financial resources restricted for plant purposes), what is owed by an institution is subtracted from what is owned by the institution and the balance represents its net assets. Operating expenses are the amounts invested to pay the annual costs (e.g., salaries, utilities, supplies) related to instruction, institutional support, student services, etc. By comparing the two, it is possible to determine how long an institution could conduct operations if no new revenues were being generated. Minimal financial health for the ratio is deemed to be .4, representing approximately 140 days or one semester of operating expenses. The maximum value credited when calculating the CFI is 500 days of operating expenses, meaning an institution could operate for 1.4 years without generating revenues.
- The Viability Ratio, also representing 35 percent of the CFI, is a corollary to the primary reserve ratio. It also utilizes expendable resources to calculate the ratio. But instead of focusing on operating demand, as represented by operating expenses, it utilizes the long-term debt related to facilities. To calculate the viability ratio, expendable resources are divided by the total amount of debt and other obligations related to facilities—typically in the form of bonds, capital leases, or asset retirement obligations. The ratio indicates the amount of debt that could be repaid just from reserves. Minimal financial health for the ratio is 1.25, meaning that reserves exceed total obligations by one quarter. The maximum value credited when calculating the CFI is 4.2, meaning reserves exceed total obligations by a factor of just over four.
- The Return on Net Assets Ratio, representing 20 percent of the CFI, indicates whether an institution is better off at the end of a period than at the beginning. The ratio is calculated by dividing the change in total net assets for the period by the beginning net assets for the period. Minimal financial health for the ratio is a 6 percent return on net assets, meaning that net assets have increased during the year by 6 percent of the net assets at the beginning of the year. The maximum value credited when calculating the CFI is 20 percent.
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- The net operating revenues ratio, representing 10 percent of the CFI—indicates whether an institution was able to conduct operating activities by using just the operating revenues generated during the period. An institution able to do this will contribute to reserves by generating more operating revenues than operating expenses. Operating revenues include things like tuition, fees, grants, endowment income available for spending, and non-endowment gifts. (Endowment gifts are revenues but they are not available for operations.) The ratio is calculated by dividing the net operating revenues by the operating revenues. In other words, after subtracting operating expenses from operating revenues, the remaining amount is divided by operating revenues. Minimal financial health for the ratio is 2 percent, meaning that operating revenues exceed operating expenses by 2 percent of operating revenues. The maximum value credited when calculating the CFI is 7 percent. The combination of the four ratios results in a CFI score on a ten-point scale. A score of three represents minimal financial health and equates to the minimums described above for each ratio. Scores below three, including negative scores, are an indication of financial stress. Higher scores, for instance, those above six, indicate that the institution enjoys strong financial health and would be able to weather financial difficulties and/or invest in new programs and activities.
* See Strategic Financial Analysis for Higher Education, Seventh Edition, by Prager, Sealy & Co., LLC, KPMG, and Attain for an in-depth discussion of the CFI.
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