by SST Senior Auditor, Chris Adams
The U.S. Department of Education (“DoE”) requires schools that receive Title IV funding to meet minimum standards of financial responsibility. Schools receiving Title IV funds are required to annually submit audited financial statements to the DoE. Schools prepare three ratios that are combined to form a composite score that is used to gauge the financial health of the organization. The data that is analyzed can fluctuate from year to year, therefore the DoE provides schools with alternative methods to demonstrate their financial responsibility (i.e., cash monitoring, posting a letter of credit, etc.)
These ratios can create a composite score ranging from negative 1.0 to positive 3.0. The following indicate relative financial health:
1.5 or greater = passing (financially responsible)
1.0 to 1.49 = in the zone (financially responsible – however require additional oversight)
Less than 1.0 = (not financially responsible and subject to cash monitoring requirements, must post a letter of credit)
The three ratios used in the composite score include the following:
A. Primary Reserve Ratio – adjusted equity divided by total expenses (excluding federal and state income taxes).
Adjusted equity is calculated as follows:
Total owner(s)’ equity
Minus: intangible assets (ie. goodwill and noncompete agreements)
Minus: unsecured related-party receivables
Minus: net fixed assets
Plus: post-employment and retirement liabilities
Plus: all debt obtained for long-term purposes, unless this debt exceeds net fixed assets, then you would add back fixed assets, rather than debt.
Equals: adjusted equity
B. Equity ratio – modified equity divided by modified assets.
Modified Equity=(total owner(s)’s equity) minus (intangible assets) minus (unsecured related party receivables)
Modified Assets=Total Assets minus Intangible Assets minus Unsecured Related Party Receivables
C. Net income ratio – net income before taxes divided by total revenue
The ratios above are then multiplied by a strength factor score as follows:
Primary Reserve Strength Factor Score = 20 multiplied by the Primary Reserve ratio
Equity Strength Factor Score = 6 multiplied by the Equity ratio
Net Income Strength Factor Score = 1 + (33.3 multiplied by the net income ratio)
The strength factor scores have a minimum value of -1.0 and a maximum value of 3.0.
The strength factor adjusted ratios are then weighted for the school’s composite score (30% for primary reserve ratio, 40% for equity ratio, 30% for net income ratio).