Financial Condition Analysis Made Easy:

Financial Condition Analysis Made Easy: Using CAFR information to make financial decisions. IMMI 2010 By Larry D. Burks, MPA

Financial Condition Analysis The following is a description of the four levels of solvency and the indicator ratios associated with each type of solvency. Adopted from the financial condition analysis of states conducted by Wang, et al. (2006). Also described by Wang in Financial Management in the Public Sector: Tools, Applications, and Cases (2006, pp. 148-171). CAFRs using accrual based accounting are used for calculating solvency ratios.

STATEMENT OF ACTIVITIES

STATEMENT OF NET ASSETS Management’s Discussion and Analysis will assist in evaluating financial condition of a government this section may explain noticeable changes or trends indicated by the FCA solvency ratios

Cash Solvency • related to liquidity and effective cash management • indicates a government’s ability to generate sufficient resources to pay its current liabilities • a larger value in the solvency ratios indicates a larger amount of assets are available to cover liabilities, thus a higher level of cash solvency • Cash Ratio and Current Ratio are the two common measures

Cash Ratio • (Cash + Cash Equivalents + Investments) / Current Liabilities • measures ratio of cash, cash equivalents and investments to current liabilities • indicates ability to cover current liabilities and relates directly to short-term financial conditions • can also provide long-term indicators of cash solvency

STATEMENT OF NET ASSETS

Current Ratio • Current Assets / Current Liabilities • measures the ratio of current assets to current liabilities • ratio is an indication of a government’s ability to meet short-term financial obligations with current assets

Budget Solvency • indicates a government’s ability to generate enough revenues to fund and maintain a certain level of services • indicators used to determine budget solvency are highly associated and higher ratios indicate a higher levels of budget solvency • measurements include Operating Ratio and Surplus (Deficit) Per Capita

Operating Ratio • Total Revenues/Total Expenditures • measures the ratio of total revenues to total expenses • operating ratios greater than 1.00 indicates a budget surplus – less than 1.00 a deficit • important to the short-term financial condition • can provide feedback and opportunities to make corrections to prevent deficits over the long-term

STATEMENT OF ACTIVITIES

Surplus (Deficit) Per Capita • Total Surpluses (Deficits) / Population • measures the amount of a government’s surplus (or defect) per resident • provides information regarding spending levels per resident • deficits indicate a lack of funds, a needed increase in revenues, and room for service improvements

STATEMENT OF ACTIVITIES POPULATION

Long Run Solvency • indicates future resource availability of governments • determined largely by current long-term obligations or liabilities • combination of the 3 ratios used have both positive and negative relationships • Net Asset Ratios have a negative association with Long-term Liability ratios and Long-term Liability Per Capita • both liability ratios have a positive relationship

Net Asset Ratio • Net Assets / Total Assets • measures the portion of net assets compared to total assets • larger ratio indicates a higher level of long-run solvency • determines what percentage of total assets is paid for and what percentage of total assets is still classified as a liability • indicator provides a clear picture of a government’s future spending and ability • indicates ability to overcome emergencies and down cycles in the economy

Long-term Liability Ratio • Long-term Liabilities / Total Assets • measures a government’s ability to pay off long-term debt by comparing long-term liabilities to total assets • higher ratio indicates lower level of ability to pay off long-term debt or a strain on future resources • higher ratio indicates increasing levels of long-term obligation

Long-term Liability Per Capita • Long-term Liabilities / Population • measures the amount of long-term liability per resident • analyst can determine the level of debt incurred in relation to the population • higher levels of debt per person, indicates a declining level of long-term solvency • also suggests declining levels of service delivery as a whole over the long-term

STATEMENT OF NET ASSETS POPULATION

Service Solvency • measures government’s ability to pay and sustain existing service levels • Tax Per Capita ratio and Revenue Per Capita ratio measure tax burden and revenue burden of residents • Expenditure Per Capita ratio is an indication of the cost of services per resident • all three indicators will show lower levels of service solvency as the indicator figures increase

Tax Per Capita • Taxes / Population • measures the relationship between taxes paid per resident of the population • provides a calculation to determine how much tax burden per resident in a state is collected to cover liabilities and expenses • useful to monitor increases and decreases in tax revenue • illustrates the costs of running government and providing services to each taxpayer

Revenue Per Capita • Total Revenues / Population • measures taxes but includes all other revenues such as fees and fines • provides a calculation determining how much total revenue was collected per resident of a government to cover liabilities and expenses • illustrates the increases and decreases in revenue collection • trends can help analyst predict a government’s ability to provide services to its community or find a cause and effect relationship

Expenditure Per Capita • Total Expenses / Population • measures resident’s burden in relation to a government’s total expenses • also provides an indication of how well services are managed • the higher the contribution per resident, the lower the service solvency level • can provide information to find causes of changes and provide solutions to correct a situation if needed

Financial Condition Analysis Made Easy: