10-1 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 2 2-5. Budgets establish the amount of resources that are available for specific activities. However, budgets do not merely limit the resources that can be spent. They represent the detailed plan that supports the organization’s efforts to achieve its mission, and help the organization determine and achieve its goals and objectives. The budgeting process is one of exploring possibilities. Organizations determine what things they can and cannot do. They examine alternatives and choose those that are likely to yield the best results. They become attuned to possible problems and can work to find solutions. Budgeting forces managers to think ahead, to have clear expectations against which to measure performance, and to coordinate the activities of the organization so that everyone is working toward a common purpose. Budgets are also used to control results. That is, budgets not only create plans, but they are also used to help accomplish those plans. This is done by comparing actual results to the budget. Looking at results, we can assess what needs to be corrected. How good a job did the organization’s management do? How well did the organization itself do? In order to evaluate performance, one must have a standard or benchmark to compare with actual results. The budget establishes the organization’s expectations. 2-6. An organization may consider undertaking an activity that was not planned for when the annual budget was prepared. At any time an organization can prepare a special budget for a specific purpose. Appropriate approval should be obtained before implementing the budget. 2-12. If targets are placed out of reach, people probably will not stretch to their utmost limits to come as close to the target as possible. When people work extremely hard and then fail, they often question why they bothered to work so hard. If hard work results in failure to achieve the target, then why not ease off? If you are going to fail anyway, must it be so painful? 2-13. (1) The budget is first prepared. (2) After review by the body with adoption authority, it is adopted, either with or without changes. (3) Once approved, the budget is implemented. It is the responsibility of the management of the organization or the executive branch of the government to assure that the adopted budget is carried out. (4) Finally, the results must be evaluated. Accountability is an element of this evaluation. 2-14. In some organizations, support and revenues are only acknowledged if they have been received in cash. In those cases, expenses are recognized when they have been paid. For organizations that record their revenues and expenses in that way, the cash budget would be identical to the operating budget. They are said to use a cash basis of accounting. In contrast, if revenue is recorded in the year the service is provided, whether cash has been received yet or not, then the organization is said to be using an accrual basis of accounting. Cash accounting is easier, but does it enable us to understand how well our organization is doing? With accrual accounting we accrue, or anticipate, the eventual receipt of money for services provided, as well as recording expenses for resources consumed, even if they have not yet been paid for. When accrual accounting is used, the operating budget gives us a good idea of how profitable we expect the organization to be. However, it does not give an accurate idea of how much cash we will have. 10-2 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 2-17. Cash Accrual Basis Basis Revenue $ 15,000 $ 20,000 Expense $ 16,000 $ 18,000 Surplus/(Deficit) ($ 1,000) $ 2,000 Accrual better reflects the long-term stability of the organization. 2-19. Monroe Outpatient Surgery Center Operating Budget June 2012 Revenues $200,000 (80 procedures x $2,500/procedure) Expenses Professional Fees $120,000 (80 procedures x $1,500/procedure) Surgical Supplies 24,000 (80 procedures x $300/procedure) Salaries 10,500 Given Occupancy 8,200 Given Communication 1,200 Given Depreciation 4,000 ($240,000/60 months) Total Expenses $167,900 Profit $ 32,100 2-21. Operating budget Cash budget Revenue $240,000 Beginning Balance $26,000 Cash Receipts Expenses Collection from Feb. 150,000 Personnel 160,000 Collection from March 60,000 Supplies 48,000 Cash from mortgage 250,000 Depreciation 12,000 Total Cash Receipts 460,000 Interest 6,000 Available Cash 486,000 Cash Disbursement Total Expenses 226,000 Payroll payment 170,000 Payment to suppliers 45,000 Surplus/(Deficit) $14,000 Payment for building 250,000 Total Disbursements 465,000 Ending Cash Balance $ 21,000 10-3 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Capital budget Building $250,000 Mortgage $250,000 2-23. (Special Purpose Budget) Budget Revenue 700 screenings Supermarket Subsidy $1,000 Total Revenue $1,000 Less Expenses Equipment rental $ 500 Nurses $50 10 hours 7 days 3,500 Test Costs 700 $1 700 Total Expenses $4,700 Surplus/loss $ (3,700) No, it is not necessarily financially bad. This program may discover patients with hypertension or other medical problems who will become patients of the hospital, generating additional revenues. Also it provides the hospital with a way to advertise their services, generating future patient volume and revenue. 10-4 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 3 3-4. A top-down budget is one that is prepared by top management. The budgeted amount is given to responsibility center managers, who are expected to achieve the budgeted result. However, it is very difficult for top managers to be aware of all of the likely factors affecting spending in each responsibility unit. An alternative approach is bottom-up, in which responsibility unit managers propose budgets for their unit and provide justification for the requested spending. A bottom-up approach makes better use of the expertise of employees throughout the organization, is more likely to result in employees who want to achieve the budget, and is more likely to be achieved. However, it requires top management willing to accept some degree of decentralization. In very autocratic, centralized organizations where top management desires retention of high levels of control, a top-down budget is more likely to be employed. 3-9. Performance budgeting is an approach designed to improve the budget process by focusing more on what we hope to accomplish than simply on inputs used. The method calls upon the manager and organization to define goals, plan the amount of resources needed to accomplish those goals, and then assess how well the goals have been achieved. The method is particularly useful when it is possible to apparently do the same amount of work with different budgeted amounts of resources (e.g., maintain ten parks), yet the underlying quality of worked performed does not remain constant. The first step is to clearly define objectives, referred to as performance areas. Next, one must identify the operating budget. Then the percent of operating budget resources that will be devoted to each objective must be determined. The operating budget resources can then be allocated to the performance areas. Measures of performance for each objective or performance area must be established. Then a performance budget can be developed. 3-11. This is a technique that argues that all costs in the budget must be justified each year, not just budget increases from year to year. The method also focuses on the evaluation of alternatives and their costs and benefits. 3-13. A flexible budget is an operating budget for varying workload levels. It gives managers an understanding of what is likely to happen to revenues, expenses, and profits (surpluses or deficits) if the volume of services provided varies from the expected level. 3-19 1. i Zero-Based 2. vi Flexible 10-5 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 3-24. (Flexible Budget) . Price $ 5.00 $ 6.00 $ 7.00 Volume 20,000 18,000 16,000 Revenue $ 100,000 $ 108,000 $ 112,000 Less Fixed Cost 32,000 32,000 32,000 Less Variable Cost $4 Volume 80,000 72,000 64,000 Surplus/(Deficit) $(12,000) $ 4,000 $16,000 Change the price to $6. Assuming this is a Not-for-Profit organization with a mission to provide care, a price of $5 puts it at risk of closing. A price of $7 makes a larger profit, but fewer patients receive care. The $6 price balances the need to make a profit with the desire to maximize care offered. 3-32. SALARIES, BENEFITS, SUPPLIES, RENT, INTEREST, ETC. 3-33. A. FLEXIBLE B. CAPITAL BUDGETS C. ZERO-BASED D. ACCRUAL 3-34. Revenue 10% Decrease Base  10% Increase Grant $100,000 $100,000 $100,000 Fares (V*.8*.75) 2,700 3,000 3,300 $102,700 $103,000 $103,300 Expenses Supervisor $36,000 $36,000 $36,000 Coordinators (6*17*10*50) 51,000 51,000 51,000 Insurance (1750*2) 3,500 3,500 3,500 Supplies/copying 2,500 2,500 2,500 Mileage (V*.35*5) 7,875 8,750 9,625 $100,875 $101,750 $102,625 Excess/(Deficit) $1,825 $ 1,250 $675 10-6 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 4 4-2. Full cost refers to the total of all costs associated with a cost objective. This includes direct and indirect costs. Direct costs are the costs incurred within the organizational unit for which the manager has responsibility, or the costs of resources for direct production of a good or service. Indirect costs are costs that are assigned to an organizational unit from elsewhere in the organization, or costs of resources that are not used for direct production of a good or service. Direct and indirect costs are particularly difficult to understand because their definitions relate to the object of the analysis. If one is interested in the direct cost of the public works department, it is appropriate to include department supervisory personnel in that cost. In contrast, if one is interested in the direct cost per mile of road plowed, that would include the plow, the driver, and the cost of the salt spread on the road, but not the cost of supervisory personnel. In that example, the supervisors are direct costs of the public works department (i.e., what it costs to operate the public works department) but indirect costs of plowing the road (i.e., what it costs to plow the roads). The various scheduling and other administrative activities carried out by supervisory personnel are essential to running the department, but they are not a direct cost of plowing snow. 4-3. Average cost is the full cost of any cost objective divided by the number of units of service provided. Fixed costs: those costs that do not change in total as the volume of service units changes over a relevant range of activity. Variable costs: those costs that vary directly with changes in the volume of service units over a relevant range of activity. If all of the costs of plowing snow, both direct and indirect, are added and the total is divided by the number of units, the result is the cost per unit or the average cost. So, the total cost could be divided by the number of miles to find the cost per mile plowed. Once Meals for the Homeless (Meals) rents space for a soup kitchen, the rent will not change from day to day, even if the number of meals provided varies by a substantial amount. Perhaps Meals is serving 300 people a day at a given soup kitchen. If Meals were to feed another person, the rent would stay the same. Therefore, it is a fixed cost. In contrast, the amount of food that Meals must purchase represents a variable cost. If more people are served, meals will need more food. Activity represents the volume of services provided. 4-4. Marginal costs are the extra costs incurred as a result of providing one more service unit (such as one more meal). At first, marginal costs would appear to be identical to variable costs. In both cases, if there is one more unit of activity, there will be an increase only in variable costs. Marginal costs, however, more broadly look at all costs that might change as a result of a decision. Suppose that HOS has an x-ray machine that can take 5,000 x-rays per year. What is the cost of doing one more x-ray? If HOS has to buy another machine to do the 5,001st x-ray, then on the margin, the costs of the additional patient are the variable cost of one more patient plus the cost of acquiring another machine. 4-5. Cost per unit depends on volume. If volume is low, the cost per unit is higher than if volume is high. This is because as volume rises, fixed costs get shared resulting in less fixed cost per unit. Furthermore, for historical purposes measuring the average cost may be adequate. For prospective decision making, we are often interested in the marginal costs. Therefore the appropriate measure of cost depends in part on the reason we want to know the cost. 4-12. a. Fixed: depreciation, doctor, nurse, cooks and camp director 10-7 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E b. Step-Fixed or Semi-Variable costs: counselors c. Variable: food and transportation d. Not included in the camp’s cash budget: depreciation 4-15. 1. BEQ = FC/(VR – VC) = ($5,000 per week/5 days per week)/((15-5)) = 1000/10 = 100 per day 2. b. decreases 4-20. 1. Full Cost. 2. Average Cost. 3. Marginal Cost. 4-22. 1. d. Unit variable cost remains constant and unit fixed cost decrease 2. d. Relevant range 4-26. 1. ___total revenue__ equals __total expense____ 2. ___price or variable revenue___ minus __variable cost_____. 3. b. decreases 4-28. b. reduce the contribution margin per unit of service. 4-34. Weighted Average Price .30 * $100 = 30 .70*.80*$100 = 56 $86 FC = $210,000 VC = $65 per exam P = $86 per exam BEQ = $210,000 / (86 – 65) = 10,000 exams Or: (100-65) x .3 + (80-65) x .7 = $21 = WACM 4-36. 1. Breakeven 10-8 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Number of = Total Fixed Expenses/Unit Contribution Margin People = ($5,000 + $1,000) / ($150 - $50) = 60 people 2. Average cost = Total cost / volume TC= 6,000 + (50*100) = 11,000 AC= 11,000 / 100 = $110 per person 4-37. 1. Fixed costs = $180 VC= 5 Q=12 Q = FC/(P – VC) 12=180/(P-5) 12(P-5)=180 12P-60=180 12P=240 P=$20 2. Fixed costs = $180+300 = $480 treat profit as a fixed cost VC= 5 Q=12 Q = FC/(P – VC) 12=480/(P-5) 12(P-5)=480 12P-60=480 12P=540 P=$45 4-40. 1. BEQ = (FC-City revenue)/(Weighted VR – Weighted VC) or BEQ = (FC-City revenue)/(Weighted CM) Base Reading Daily Price $10.00 $3.00 Daily VC $3.00 $5.00 Days per week 5 Fixed Costs $36,000 City Contract $30,000 Weekly Weekly Weekly Weekly Mix Price VC CM Weighted CM non reading 70.0% $50.00 $15.00 $35.00 $24.50 reading 30.0% $65.00 $40.00 $25.00 $7.50 Total Weighted CM $32.00 Break Even 188 2. a. increases 10-9 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 5 5-6. Compound interest simply refers to the fact that when money is invested going forward in time, at some point the interest earned on the money starts to earn interest itself. Discounting is just the reversal of this process as we go backward in time. 5-8. The net present cost method is very helpful for comparing projects that have identical lifetimes. If projects have differing lifetimes, you are not comparing equal benefits unless you equalize the lifetimes. We could use the lowest common denominator of the lifetimes, extending both alternatives until their lifetimes are equal. However, the uncertainties in replacement and operating costs going forward in time may be substantial. The annualized cost method overcomes these problems. In that approach, one first finds the Net Present Cost for each alternative. Then, that cost is translated into a periodic payment for the number of years of that individual project’s lifetime. The project with the lower annualized cost is less expensive, on an annual basis, in today’s dollars. 5-9. Aside from the complexity of calculations, when cash flows are uneven from year to year, there are two important limitations. IRR assumes that cash inflows during the project are reinvested at the same rate that the project earns. Second, sometimes use of the IRR method will cause you to chose incorrectly from two mutually exclusive projects by picking a smaller project with a higher IRR rather than a larger project with a somewhat smaller IRR. 5-10. The objection to the method is that it ignores everything that happens after the payback period. It also does not consider the time value of money. 5-22 (Annualized Cost) French Corp Annual Costs: PMT = $10,000, N = 10, I = 10% PV = $61,446 Net Present Cost: $275,000 (purchase cost) + $61,446 = $336,446 Annualized Cost: PV = $336,446, N = 10, I = 10% PMT = $54,755 Japan Rail Car Annual Costs: PMT = $15,000, N = 6, I = 10% PV = $65,329 Net Present Cost: $195,000 (purchase cost) + $65,329= $260,329 Annualized Cost: PV = $260,329, N = 6, I = 10% PMT = $59,773 Select French Corp. Their cars have a lower annualized cost 10-10 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 5-24. (Annualized Cost) Model A Model B Outlay ($80,000) ($100,000) Annual Payment $5,000 $2,500 i= 5% 5% N= 20 years 30 years PV of a PMT of $5,000 $2,500 At 5% for 20 years 30 years = $62,311 $38,431 Plus Outlay 80,000 100,000 = $142,311 $138,431 Annualized PMT for N 20 years 30 years I 5% 5% PV $142,311 $138,431 Annualized cost $11,419 $9,005 Spreadsheet Formula Solution Model A Present Value = PV(rate,nper,pmt,fv,type)-80000 = PV(5%,20,5000)-80000 = ($142,311.05) Model A Annualized Cost = PMT(rate,nper,pv,fv,type) = PMT(5%,20,142311.05) = $(11,419.41) Model B Present Value = PV(rate,nper,pmt,fv,type)-100000 = PV(5%,30,2500)-100000 = ($138,431,13) Model B Annualized Cost = PMT(rate,nper,pv,fv,type) = PMT(5%,30,138431.13) = ($9,005.14) 10-11 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Model A will cost $11,419 per year in today’s dollars, and Model B will cost $9,005, so Model B is less expensive. 5-25. (NET PRESENT VALUE) Cash In Cash Out Net cash flow Year 0 650 –650 0 140 25 115 1 140 25 115 2 140 25 115 3 340 25 315 4 NPV(12%, values…) -650 = (173.60) NPV 102.68 9168 8185 20019 650 17360 . . . . Decision: Do NOT pursue the investment. It has a negative net present value. 5-31. (IRR) Spreadsheet Formula Solution = Rate(nper,pmt,pv,fv,type,guess) = Rate(7,800,-5000) = 2.92% 5-32. (IRR) Spreadsheet Formula Solution = Rate(nper,pmt,pv,fv,type,guess) = Rate(36,5000,-125000) = 2.12% per month = 25.5% Annual rate exceeds 18%, so accept the contract. 10-12 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 6 6-1. Long-term debt includes unsecured notes, notes secured with collateral, mortgages, bonds, and leases. 6-2. Collateral is a specific asset that the lender will be able to take possession of if the borrower fails to make payment of amounts due. For example, if the organization has made an investment, buying 10,000 shares of Microsoft stock, it may offer that stock as collateral when it borrows money. By providing the lender with specific valuable collateral, the loan is less risky. Therefore, the lender is more likely to be willing to make the loan and to charge a lower interest rate. 6-5. Leasing is more flexible, can save money, can protect you from unexpected events, can provide a higher level of financing, and can have tax advantages. If you expect to need a piece of equipment for only half of its useful life, you can set the lease term for that period and will not have to get involved with selling it, as you would if you purchased the item. Leases may protect you from obsolescence. They provide 100% financing. In some cases, a for-profit organization can save taxes by purchasing certain items and pass some of that tax savings on to the not-for-profit organization in the form of lower lease payments. 6-8. 1. PMT=5,000,000*(6%/2)= 150,000 2a. $5,000,000 – NO CALCULATION NECESSARY 2b. FV=5,000,000 PMT=150,000 N=60 I=2.9 PV = $5,141,393.25 6-9. N= 20 years remaining * 2 payments per year = 40 I = 4.6% /2 compounding periods per year = 2.3% Payment = $3,000,000 = 6%/2 * $100,000,000 Future Value = $100,000,000 Par Value of Bond $100,000,000 Coupon Interest Rate 6% Market Interest Rate 4.6% Years remaining 20 Compounding periods/year 2 I 2.30% N 40 Payment $3,000,000 FV $100,000,000 PV of interest payments $77,909,539.62 PV of Principal repayment $40,269,352.96 Value of the Bond $118,178,892.58 10-13 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 6-12. (Bonds) Spreadsheet Formula Solution a. = PV(rate,nper,pmt,fv,type) = PV(6.5%,30,-300,-5000) = $4,673.53 b. $4,673.53 x 10,000 = $46,735,331 6-14. (Bond) B. Spreadsheet Formula Solution = PV(rate,nper,pmt,fv,type) = PV(5%,20,-4000,-100000) = $87,537.79 6-16 (see separate Excel Spreadsheet) 10-14 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 7 7-29 Payer Total A/R Current 31-60 days 61-90 days 91+ days Medicare 5,000,000 2,500,000 1,000,000 1,500,000 - Medicaid 3,000,000 900,000 900,000 900,000 300,000 Insurance 4,000,000 2,000,000 2,000,000 - - Self Pay 2,000,000 500,000 500,000 500,000 500,000 14,000,000 5,900,000 4,400,000 2,900,000 800,000 7-30 Implicit Interest Lost by Paying Early = (Discount/Discount Price) x 365/(Days Sooner) =(3,600*0.01*0.20)/(3,600*0.99*0.20) x (365/20) = 18.4% > 7% … don’t take discount 7-32 I = P x R x T = 28,000 x 7% x (3/12) = $490 $ 28,000 Principal $ 490 Interest $ 28, 490 Repayment 7-33 If ordering @ EOQ: EOQ = [(2ON)/C]^.5 = [(2 * $20 * 30,000) / (.3 + (5% *$4))]^.5 = 1, 550 cans (rounded) 10-15 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E # Orders per year = N/EOQ = 30,000/1,550 = 19.35 = 20 orders (rounded) Carrying Cost = CQ/2 = (.5 * 1550) / 2 = $388 (rounded) Ordering Cost = ON/Q = ($20)(30,000)/1,550 = $387 (rounded) Product Cost = P x N = $4 x 30,000 = $120,000 Total Inventory Cost = CC + OC + PC = 388+387+120,000 = $120,775 If ordering all cans @ beginning of the year: Carrying Cost = 30,000 x .50 = $15,000 Ordering Cost = $20 x 1 order = $20 Product Cost = P x N = $4 x 30,000 = $120,000 Total Inventory Cost = $135,020 > $120,775 (lowest possible) 10-16 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 8 8-10. Variances are calculated for three principal reasons. By understanding why results were not as expected, the budget process can be improved and made more accurate in future planning. Second, by understanding why variances are occurring, actions can be taken to avoid additional unfavorable variances over the coming months. The third reason for variance analysis is to evaluate the performance of units or departments and their managers. 8-15. This may or may not be the case. It depends largely on how revenues change as volume changes. Volume increases that increase revenues may be good for the organization, even though some expenses are rising as well. If some costs are fixed, it is possible for volume increases to cause revenues to increase by more than expenses increase, resulting in larger profits or smaller losses. 8-17. Using the flexible budget technique, the variance for any line item can be subdivided into three pieces: a volume variance, a price variance, and a quantity variance. The volume variance is defined as the portion of the variance in any line item that is caused by the fact that the output level differed from the budgeted expectation. The price, or rate, variance is the portion of the total variance for any line item that is caused by spending more per unit of some input resource than had been anticipated. The quantity, or use, variance is the portion of the overall variance for a particular line item that results from using more of a resource than was expected for a given output level. These three variances together equal the traditional variance for a line item. 8-19. The more we aggregate information, the greater the chance that we will misinterpret what has happened. An entire organization may spend nearly the same amount for a given month as it expected. In total, there is nearly no variance. However, that does not mean that there are no problems that need to be investigated. Some departments might have large favorable variances and other departments might have large unfavorable variances. Within just one department, two line items might have offsetting variances, both of which should be investigated. Even within one line item, there may be offsetting price, quantity, and volume variances that warrant attention. 8-22. No. Variances can result from uncontrollable, random events. If a variance is very small, it is often not worth the manager’s time to investigate. However, it requires skill and experience to know when a variance is large enough to indicate the possibility of problems that require management investigation. 8-25. The total variance is $90,000 – (400 * 4 * $55) or $88,000 = 2,000 U The variance is unfavorable because the expense was higher than they had anticipated 10-17 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 8-27. (Expense Variances) Calculate the volume, quantity, and rate variances, and provide some possible explanations for each. Original Budget: Budgeted Volume x Budgeted Quantity x Budgeted Rate Flex Budget: Actual Volume x Budgeted Quantity x Budgeted Rate or 125 x 10 x $20 = $25,000 - 150 x 10 x $20 = - $30,000 Volume Variance = $ (5,000) U Flex Budget: Actual Volume x Budgeted Quantity x Budgeted Rate VQA Budget: Actual Volume x Actual Quantity x Budgeted Rate or 150 x 10 x $20 = $30,000 - 150 x 8 x $20 = - $24,000 Quantity Variance = $ 6,000 F VQA Budget: Actual Volume x Actual Quantity x Budgeted Rate Actual: Actual Volume x Actual Quantity x Actual Rate or 150 x 8 x $20 = $24,000 - 150 x 8 x $25 = - $30,000 Price Variance = $ (6,000) U Investigation of why there were 20% more trials is required. The $5,000 Unfavorable Volume Variance might reflect an increased amount of crime, or simply greater efficiency of the Courts in providing a speedy trial. The Judge is correct in arguing that more cases tend to raise costs, other things being equal. However, everything else did not stay the same. The trials have become shorter resulting in a Favorable Quantity Variance of $6,000. Shorter trials require less labor hours. This could reflect greater efficiency, or simply a mix of cases that tend to be shorter. If it is the result of efficiency, that improvement should be noted and rewarded to encourage its continuation. In any case, the shorter trials more than made up for the increased number of trials. The Unfavorable Rate Variance caused spending of $6,000 over the expected level. One might argue that the additional volume of cases required overtime, accounting for the higher wage. However, because the trials were shorter we actually used only 2,400 labor hours as compared to the 2,500 budgeted. The variance could be due to a new union contract, or perhaps we hired stenographers with more experience who earn a higher wage. Perhaps there was a payroll error, and the stenographers were paid at the wrong hourly wage. In any event, investigation of this rate variance is clearly warranted. 8-29. (Revenue Variances) Budget Actual Variance 10-18 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 300 $3,000 400 $2,700 Revenue $900,000 $1,080,000 180,000 F Price variance—average sale price per car Volume variance—number of cars donated Original Budget: Budgeted Volume x Budgeted Mix x Budgeted Price Cars: 300 x 100% x $3,000 = $ 900,000 Flex Budget: Actual Volume x Budgeted Mix x Budgeted Price Cars: 400 x 100% x $3,000 = $1,200,000 Original Budget: $ 900,000 Flex Budget: - 1,200,000 Volume Variance = $ 300,000 F VMA Budget: Actual Volume x Actual Mix x Budgeted Price Cars: 400 x 100% x $3,000 = $1,200,000 Flex Budget: $1,200,000 VMA Budget: - 1,200,000 Mix Variance = $ 0U Since there is only one type of product, the mix variance must be zero. Actual: Actual Volume x Actual Mix x Actual Price Cars: 400 x 100% x $2,700 = $1,080,000 VMA Budget: $1,200,000 Actual: - 1,080,000 Price Variance = $ 120,000 U 10-19 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 9 9-1. Assets are anything of value that the organization owns. Liabilities are obligations owed to outsiders. Owner’s equity represents the share of the organization’s assets owned by its owners. 9-5. GAAP, or Generally Accepted Accounting Principles, are a set of rules and conventions. They are established by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). The CPA’s audit examines the financial statements and the underlying financial records of an organization. Based on their examination, they issue a letter that gives their opinion as to whether the financial statements are free of material (substantial) misstatements and whether they conform to Generally Accepted Accounting Principles (GAAP). GAAP help create some degree of uniformity. 9-11. CPAs try to find and eliminate all material errors. However, it is virtually impossible to find every error. Material errors are those that might affect a decision made by a user of the financial report. 9-12. GAAP require organizations to report their financial position and results of operations on an accrual basis. This means that revenues are recorded in the year that the organization provides goods or services and becomes legally entitled to payment. Expenses are recorded in the year that assets have been consumed in the process of providing goods and services. This contrasts sharply with the cash basis of accounting, which would record revenue when cash is received and expense when cash is paid. The rationale for using accrual accounting is that it provides a better measure of how well the organization has done for the year. The cash basis can be quite misleading because there may be a poor matching of revenue and expense in any one year. This can lead to substantially over or understated measures of income. 9-13. The primary requirement for classification as a current asset is management’s expectation or intention to convert the asset to cash or use it up within a year. Thus, an investment in Microsoft stock would be a current asset only if we expect to sell it in the coming year. Otherwise the stock would be treated as a long-term asset. 9-26. (Transactions Analysis) Date Assets (A) = Liabilities (L) + Net Assets (NA) 1. Cash Note Payable + $50,000 = + $50,000 + No change 2. Cash – $50,000 = No change + No change 10-20 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Furniture + $50,000 3. Cash + $500,000 = No change + No change Pledges Receivable – $500,000 4. Cash = No change + No change – $10,000 Brochures Inventory + $10,000 5. No transaction recorded. 6. Cash Grants Payable – $700,000 = – $700,000 + No change 10-21 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Journal Entries Dr. Cr. 1. Cash $50,000 Notes Payable $50,000 2. Furniture $50,000 Cash $50,000 3. Cash $500,000 Pledges Receivable $500,000 4. Brochures Inventory $10,000 Cash $10,000 5. No transaction is recorded. 6. Grants Payable $700,000 Cash $700,000 9-27. (Transactions Analysis Worksheet) Assets = Liabilities and Net Assets Liabilities Net Assets Pledges Brochures Tempo- Perma- Receiv- Inven- Invest- Grants Notes Unre- rarily nently Cash Able tory ments Furniture Payable Payable Stricted restricted restricted Beginning $ 270,000 $500,000 $ 1,000 $830,000 $ 0 $700,000 $ 0 $101,000 $700,000 $100,000 Balance Transaction # 1 50,000 50,000 Transaction # 2 (50,000) 50,000 Transaction # 3 500,000 (500,000) Transaction # 4 (10,000) 10,000 Transaction # 5 Transaction # 6 (700,000) (700,000) Ending Balance $ 60,000 $ 0 $11,000 $830,000 $50,000 $ 0 $50,000 $101,000 $700,000 $100,000 10-22 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 9-28 (Balance Sheet) FAAD Statement of Financial Position as of the End of the Fiscal Year Assets Current assets Cash $ 60,000 Brochures Inventory 11,000 Total current assets $ 71,000 Long-term assets Investments $830,000 Furniture 50,000 Total long-term assets $880,000 Total Assets $951,000 Liabilities & Net Assets Liabilities Long-term liabilities Notes payable $ 50,000 Total long-term liabilities $ 50,000 Total Liabilities $ 50,000 Net assets Unrestricted $ 101,000 Temporarily restricted 700,000 Permanently restricted 100,000 Total net assets $901,000 Liabilities and Net Assets $951,000 10-23 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 10 10-3. Revenues and expenses can only be recorded if certain conditions are met. Revenues are recorded if they have been earned and realized. The first requirement, being earned, is met only if the organization has provided goods or services to the customer. If a legal transfer has occurred, raising a legal right to collect payment, then the revenues have been earned. To be realized we must be able to objectively measure the amount of money owed, and there must be a reasonable likelihood of eventual collection. Support recognition is allowed even though the gift has not been received, and even though no goods or services have actually been provided. In fact, pledges are enforceable contracts. We record pledges as support if there is a specific amount and a reasonable likelihood of collection. 10-8. No. The primary goal of depreciation is not determining the current value of the asset to place on the balance sheet. Depreciation strives to allocate the cost of the asset over the asset’s useful life. In accord with the matching principle of GAAP, the goal of depreciation is to assign expense for use of the asset into the periods that the asset is used up, generating revenue. Depreciation is based on assigning the cost incurred when we acquired the asset, rather than on some measure of replacement cost if we were to buy the asset now. 10-9. At best, estimates are subjective guesses. We can try to base them on historical experience, but they still introduce the possibility of errors into the financial statements. Another problem is that estimates open the door to manipulating results. If we want to look poor to encourage donations, we might be tempted to overstate bad debt expense or to underestimate the salvage value of a piece of equipment. Both of those actions would tend to lower current net income, making us look poorer now. Estimates increase the chances that the financial statements will not be free of material misstatements. 10-11. The statement shows Cash Flows from Operating Activities, Cash Flows from Investing Activities, and Cash Flows from Financing Activities. Cash from operating activities helps us understand the organization’s ability to continue operations over time. If this number is positive, then the routine operations are self-sustaining. Cash from investing activities allows us to determine if the organization is spending cash to either acquire productive assets or investments in stocks and bonds. Alternatively, we might learn that the organization is selling its fixed assets to raise cash. That would send a warning signal of potential problems. Cash from financing activities shows sources of cash such as loans and issuance of stock. If the organization is taking out long-term loans to finance cash losses from current operations, that would also send a warning signal. 10-12. The balance sheet, activity statement, and cash flow statement are interconnected. The information from each relies to some extent on information from the others. Suppose that we use 10-24 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E up inventory as we provide services during the year. Our asset—inventory—goes down on the balance sheet. Our expense related to supply use increases on the activity statements. Just the reverse happens with revenues. When we charge clients for our services, accounts receivable rise, increasing assets and the balance sheet. Revenues also rise, affecting the activity statement. The net of the revenues and expenses helps account for the change in net assets on the balance sheet from the beginning to the end of the year. The cash flow statement has linkages to both the activity statement and balance sheet. The first line on the cash flow statement is the change in net assets, taken from the activity statement. The ending balance of the cash flow statement is the cash balance, which appears at the beginning of the balance sheet. The balance sheet provides information on the current assets and current liabilities (working capital). The change in each working capital account has an impact on the organization’s cash balances. These changes primarily show in the adjustments that are made in the cash from operations section of the cash flow statement. Changes in fixed assets and investments on the balance sheet are reflected in the cash from investing activities section of the cash flow statement. Similarly, financing activities will appear on the cash flow statement, but also are reflected in changes in long-term liability values on the balance sheet. 10-14. (Transactions Analysis) 1. Jan. 2. No journal entry. There has been no exchange by either party. 2. Jan. 14 Assets (A) = Liabilities (L) + Net Assets (NA) Cash + $100,000 = No change + No change Pledges receivable – $100,000 Date Dr. Cr. 1/14 Cash $100,000 Pledges receivable $100,000 Collection of pledges 3. Feb 19 Assets (A) = Liabilities (L) + Net Assets (NA) Inventory Accounts payable + $35,000 = + $15,000 + No change Cash – $20,000 10-25 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Date Dr. Cr. 2/19 Inventory $35,000 Cash $20,000 Accounts payable $15,000 Purchase gift shop inventory 4. May 15 Assets (A) = Liabilities (L) + Net Assets (NA) Deposit + $30,000 = No change + No change Cash – $30,000 Date Dr. Cr. 5/15 Deposit $30,000 Cash $30,000 Deposit on ordered equipment 5. July 12 Assets (A) = Liabilities (L) + Net Assets (NA) Equipment + $80,000 = No change + No change Deposit – $30,000 Cash – $50,000 Date Dr. Cr. 7/12 Equipment $80,000 Deposit $30,000 Cash $50,000 Received equipment 6. Dec. 28 Assets (A) = Liabilities (L) + Net Assets (NA) 10-26 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Cash Admission revenue + $74,000 = + + $74,000 Date Dr. Cr. 11/1 Cash $74,000 Admission revenue $74,000 Admission revenues for the year. Please note that in real life admission revenues would be collected throughout the year, and recorded on an ongoing basis, rather than all at once at the end. That is true with many of these transactions. This summarized approach is used for simplification purposes only. 7. Dec. 28 Assets (A) = Liabilities (L) + Net Assets (NA) Cash Wages payable Wage expense – $68,000 = – $2,000 – $73,000 Wages payable + $7,000 Alternatively one could combine the $2,000 reduction in the Wages Payable from last year with the $7,000 increase in wages payable this year, and just show Wages Payable going up by $5,000. Date Dr. Cr. 12/28 Wage expense $73,000 Wages payable $ 5,000 Cash 68,000 Record wage expense and payment 8. December 30 Assets (A) = Liabilities (L) + Net Assets (NA) Cash Sales revenue + $56,000 = + + $53,000 Accounts receivable – $6,000 Accounts receivable + $3,000 10-27 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Assets (A) = Liabilities (L) + Net Assets (NA) Inventory Cost of goods sold – $32,000 = – $32,000 Date Dr. Cr. 12/1 Cash $56,000 Cost of goods sold 32,000 Accounts receivable $ 3,000 Sales revenue 53,000 Inventory 32,000 Record gift shop sales 10-28 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 9. December 31 Assets (A) = Liabilities (L) + Net Assets (NA) Cash = Notes payable Interest expense – $134,000 – $127,000 – $7,000 Date Dr. Cr. 12/31 Interest expense $ 7,000 Notes payable 127,000 Cash $134,000 Payment on note and interest expense 10. December 31 Assets (A) = Liabilities (L) + Net Assets (NA) Building & equip., net = – Deprec. expense – $60,000 $60,000 Date Dr. Cr. 12/31 Depreciation expense $60,000 Building & equipment, net $60,000 Record depreciation expense 11. December 31 Assets (A) = Liabilities (L) + Net Assets (NA) Accounts receivable, net = – Bad debt expense – $1,000 $1,000 Date Dr. Cr. 12/31 Bad debt expense $1,000 Accounts receivable, net $1,000 Record estimated uncollectible receivables OR Assets (A) = Liabilities (L) + Net Assets (NA) Allowance for = – Bad debt expense Uncollectible Accounts – $1,000 $1,000 Date Dr. Cr. 12/31 Bad debt expense $1,000 Allowance for Uncollectible Accounts $1,000 10-8 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 10 -15. (Transactions Analysis Worksheet) (000’s omitted) Assets = Liabilities and Net Assets Net Assets Building and Accounts Equip- Tempo- Perma- Pledges Receiv- ment, Accounts Wages Notes rarily nently Cash Receivable able, Net Inventory Deposits net Payable Payable Payable Unrestricted Restricted Restricted Beginning $80 $320 $ 6 $ 0 $ 0 $550 $2 $2 $250 $ 372 $30 $300 Balance Transaction #1 Transaction #2 100 (100) Transaction #3 (20) 35 15 Transaction #4 (30) 30 Transaction #5 (50) (30) 80 Transaction #6 74 74 Admission revenue Transaction #7 (68) 5 (73) Wage expense Transaction #8 56 (3) 53 Sales revenue #8, continued (32) (32) Cost of goods sold Transaction #9 (134) (127) (7) Interest expense Transaction #10 (60) (60) Depreciation Expense Transaction #11 ___ ___ (1) ___ ____ ____ ___ ___ ___ (1) Bad debt ____ ____ expense Ending Balance $8 $220 $ 2 $3 $0 $570 = $17 $7 $123 $326 $30 $300 Trial Balance Alternatively the ―Accounts Receivable, Net‖ column could be split into two columns, one for ―Accounts Receivable‖ which would have the beginning balance and transaction 8, and one for ―Allowance for Uncollectible Accounts‖ which would have transaction 11. The Accounts Receivable ending balance would be $3. The Allowance for Uncollectible Acccounts would have an ending balance of ($1). On the balance sheet they would reported as a combined Accounts Receivable, Net amount of $2. 10-9 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 10-16. (Financial Statements) American Natural History Center Activity Statement for the Year Ending December 31, Year 2 Revenues and support Admission revenue $74,000 Sales or Gift Shop revenue 53,000 Total revenues and support $127,000 Expenses: Cost of goods sold $ 32,000 Wage expense 73,000 Interest expense 7,000 Bad debts 1,000 Depreciation 60,000 Total expenses $173,000 Increase/(Decrease) in net assets ($46,000) American Natural History Center Statement of Financial Position as of December 31, Year 2 and Year 1 Assets Liabilities & Net Assets Year 2 Year 1 Year 2 Year 1 Current assets Liabilities Cash $ 8,000 $ 80,000 Current liabilities Accounts receivable, net Accounts payable $ 17,000 $ 2,000 of estimated uncollectibles of $1,000 in Year 2 2,000 6,000 Wages payable 7,000 2,000 Pledges receivable 220,000 320,000 Inventory 3,000 0 Total current assets $ 233,000 $ 406,000 Total current liab. $ 24,000 $ 4,000 Long-term assets Long-term liabilities Fixed assets Notes payable $ 123,000 $ 250,000 Buildings and Total long-term liab. $ 123,000 $ 250,000 Equipment, net $ 570,000 $ 550,000 Total liabilities $ 147,000 $ 254,000 Total long-term assets $ 570,000 $ 550,000 Net assets Unrestricted $ 326,000 $ 372,000 Temp. restricted 30,000 30,000 Perm. restricted 300,000 300,000 Total net assets $ 656,000 $ 702,000 Total assets $ 803,000 $ 956,000 Total equities $ 803,000 $ 956,000 10-10 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E American Natural History Center Statement of Cash Flows for the Year Ending December 31, Year 2 Cash flows from operating activities Decrease in unrestricted net assets $ (46,000) Add expenses not requiring cash: Depreciation 60,000 Other adjustments: Add the decrease in receivables 4,000 Add the decrease in pledges receivable 100,000 Add the increase in wages payable 5,000 Add the increase in accounts payable 15,000 Subtract the increase in inventory (3,000) Net cash from operating activities $ 135,000 Cash flows from investing activities Purchase of equipment $ (80,000) Net cash from investing activities $ (80,000) Cash flows from financing activities Repayments of notes $ (127,000) Net cash from financing activities $ (127,000) Net increase/(decrease) in cash $ (72,000) Cash, beginning of year 80,000 Cash, end of year $ 8,000 10-17. (LIFO/FIFO Inventory) Consumption Balance left FIFO LIFO FIFO LIFO Beginning bal. 1,000 @ $17 1,000 400 0 600 Purchase Jan. 2 300 @ 21 200 300 100 0 Purchase July 1 500 @ 23 500 500 0 Inventory Inventory Expense Expense Value Value 1,000 $17 400 $17 600 $17 + 200 $21 + 300 $21 100 $21 + 500 $23 500 $23 $21,200 $24,600 $13,600 $10,200 10-11 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Note: Under LIFO 500 doses purchased on July 1 are assumed to have been used, even though only 400 doses were consumed after that date. This seems counter-intuitive. The key is that LIFO is a cost flow assumption used only to calculate inventory-related expense and ending inventory balances. It does not identify the specific inventory units that were actually consumed. 10-12 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 11 11-4. Although an activity statement includes revenues and expenses as an income statement would, it is more comprehensive, showing all changes in net assets. It uses terms such as Change in Net Assets or Change in Equity, rather than net income. Thus the Activity Statement includes the information that for-profits show in the Income Statement as well as information that would be contained in a for-profit organization’s Statement of Changes in Owner’s Equity. An income statement per se reflects revenues and expenses, gains and losses. There are other things that can affect stockholders’ equity or net assets, such as dividends, issuance of stock, or restricted donations. When items similar to these exist, they appear on an activity statement, but often do not appear on an income statement. 11-6. As ―used in nonprofit accounting, a fund is an accounting entity with a self-balancing set of accounts for recording assets, liabilities, the fund balance, and changes in the fund balance. Separate accounts are maintained for each fund to ensure that the limitations and restrictions on the use of resources are observed. Though the fund concept involves separate accounting records, it does not entail the physical segregation of resources. Fund accounting is basically a mechanism to assist in exercising control over the purpose of particular resources and amounts of those resources available for use.‖1 11-7. A variety of different funds are used in organizations, depending on the specific types of restrictions faced by the organization. Funds are divided into two main categories—unrestricted and restricted. Virtually all not-for-profit organizations have a current unrestricted or general fund. The main categories of restricted funds are donor restricted versus board restricted. Donor- restricted funds are funds that exist to comply with various requirements donors have placed at the time of donation. These might include building replacement funds, building expansion funds, endowment funds, custodian funds, and strike funds among other restricted funds. Board- restricted funds are those that are established to track the use of resources that the board has decided to devote to a specific purpose. If board-restricted resources are needed for other purposes, the board can remove the restriction, and the resources can be transferred to an unrestricted fund. 1 Vincent M. O’Reilly, Murray B. Hirsch, Philip L. Defliese, and Henry R. Jaenicke, Montgomery’s Auditing, 11th. (New York: John Wiley and Sons, 1990), 791. 10-13 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 11-8. Three types of events can occur that concern more than one fund in an organization. One is a loan, where one fund borrows money from another. A second is the sale of services, where one fund consumes services provided by another fund. The third type of event is a transfer, where one fund gives resources to another. Loans between funds are treated the same as a loan from a bank. The borrowing fund has a liability on its balance sheet, reflecting the need to repay the loan, and the lending fund has a receivable. These are called ―Due to‖ and ―Due from.‖ When one fund purchases services from another, the event is recorded by both funds just as if the organizations were totally separate. A transfer between funds is a permanent movement of resources from one fund to another. The assets and fund balance or net assets of one fund are reduced, and for another fund they are increased. Some transfers are done at the discretion of management. Other transfers may be mandatory. 11-11. Under FAS 124, investments in equity securities that have readily determinable fair values and all debt securities are reported at their fair value in the statement of financial position (balance sheet). Gains and losses, both realized and unrealized, on investments are shown in the activity statement. If a security has been sold during the year, the gain or loss has been realized and the security will not appear on the balance sheet at the end of the period, because the organization no longer owns it. 11-14. 1. c. permanently restricted 2. a. unrestricted 10-14 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 11-15. (Net Assets) a. Unrestricted b. Temporarily restricted c. Unrestricted if there is a reasonable expectation of eventual collection d. Permanently restricted e. Unrestricted f. Temporarily restricted 11-17. 1. Unrestricted, temporarily restricted, permanently restricted 2. Unrestricted may be used for any reasonable operating purposes, temporarily restricted may not be used except for certain purposes or at a certain point in time, permanently restricted net assets may not be expensed – only their earnings may be used. 3. Unrestricted – sale of items from a gift shop, Temporarily restricted – a grant that may only be used for a specific research project; permanently restricted – an endowment gift that may be invested and the interest used for a particular purpose. 10-15 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E CHAPTER 14 14-2. The first paragraph of the audit letter points out that although the auditor can provide an expert opinion, management holds primary responsibility for the contents of the financial statements. In some organizations, the auditors, in practice, provide a substantial amount of help in compiling the financial statements. It is important for managers to bear in mind that if there are later problems with the information contained in the financial statements, it is the organization’s management, rather than the auditors, who bear the primary responsibility for their content. 14-5. Financial statements, in themselves, do not provide a complete picture of the organization’s finances. Financial statements are limited in their ability to convey information. For example, fixed assets are recorded based on their historical cost, adjusted for depreciation. Therefore, the balance sheet does not convey the value of the fixed assets. Inventory may be valued on the financial statements based on a LIFO (last- in, first-out), FIFO (first-in, first-out), or weighted average cost assumption. There may be commitments to make lease payments or there may be outstanding lawsuits. There are many types of information that do not fit neatly into the financial statements, but are needed for the financial statements taken as a whole to provide the user with a fair representation of the organization’s finances. Given the wide range of possible ways to report information, it is vital to examine the notes in order to gain an understanding of which choices were made and the likely impact of those choices. A good understanding of financial position and results requires more information than the financial statements themselves can convey. For example, ―what contingent liabilities are there and are they material in amount? How old are the organization’s buildings and equipment?‖ 14-6. Ratios are used because the comparison between two numbers generates information that is more useful than either or both of the numbers separately. Ratios can be grouped in a variety of different ways. The chapter grouped them into the following six principal types: (1) common size (2) liquidity (3) asset turnover (4) leverage (5) coverage, and (6) profitability. A common size ratio compares all the numbers on a financial statement to one key number. For example, each asset on the balance sheet is compared to total assets. One of the difficult aspects of comparing different organizations is that they may be substantially different in size. A common size ratio attempts to make the numbers on the financial statement more comparable by stating them terms of a key number such as total assets or total revenue. Liquidity ratios focus on whether the organization has enough cash and other liquid resources to meet its obligations in the near term. At the same time, we can use liquidity ratios to assess whether the organization is wastefully maintaining too much liquidity. If liquidity is excessive, long-term investments with high relevance to the organization’s mission and perhaps high profit potential may be lost. A set of ratios called asset turnover ratios (sometimes called efficiency ratios) can help assure that resources are being used efficiently. The ratios in this category are related 10-16 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E to timely collection of receivables, appropriateness of inventory levels, and appropriate amounts of fixed assets and total assets. Leverage refers to the extent to which an organization supports its activities by using debt. The greater the debt, the riskier the organization becomes. In contrast to the liquidity ratios, which seek to assess short-term risk, the leverage ratios provide insight into the ability of the organization to meet its long-term obligations. Some would argue that coverage ratios are even more critical. They examine the organization’s capacity to make debt service payments (interest and/or principal) as they come due. Virtually all organizations need to earn a profit to be financially healthy—to be able to replace equipment, acquire new technologies, and expand services and to be able to meet the challenges of the future. At the same time, it might be inappropriate for many not-for- profit organizations to make an excessive profit. Profitability ratios can help the manager and outside users assess whether the organization is making an adequate, but not excessive, profit. 14-10. (Financial Analysis) Part A. DAV Statements of Financial Position Common Size Ratios December 30, 2007 December 30, 2006 % $ % $ ASSETS CASH AND CASH EQUIVALENTS 14.35% 1,909,606 9.38% 1,044,193 INTEREST AND DIVIDENDS RECEIVABLE 0.46% 61,244 0.47% 52,582 CAMPAIGNS’ PLEDGES RECEIVABLE 2.81% 373,788 3.22% 358,632 PREPAID EXPENSES AND OTHER 0.12% 16,244 0.23% 25,367 INVESTMENTS 82.26% 10,944,924 86.70% 9,653,039 TOTAL 100.00% 13,305,806 100.00% 11,133,813 LIABILITIES AND NET ASSETS LIABILITIES: Accounts payable — DAV 1.52% 201,721 1.54% 171,550 Accounts payable — other 0.01% 910 0.01% 1,017 Annuity payment liability 28.99% 3,857,262 33.04% 3,679,148 Total liabilities 30.51% 4,059,893 34.59% 3,851,715 UNRESTRICTED NET ASSETS 69.49% 9,245,913 65.41% 7,282,098 10-17 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E TOTAL 100.00% 13,305,806 100.00% 11,133,813 10-18 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E DAV Statements ofActivities Common Size Ratios December 30, 2007 December 30, 2006 % $ % $ SUPPORT AND REVENUE: Contributions 59.96% 4,771,172 7.44% 2,654,400 Contributions of charitable gift annuities 3.03% 241,245 0.50% 178,626 Bequests 27.38% 2,178,924 90.98% 32,436,803 Investment income — net 9.63% 766,580 1.08% 384,670 Total support and revenue 100.00% 7,957,921 100.00% 35,654,499 EXPENSES: Program services 76.07% 6,053,675 97.48% 34,754,236 Management and general 1.08% 85,933 0.21% 75,499 Fundraising 2.25% 179,277 0.47% 168,316 Total expenses 79.40% 6,318,885 98.16% 34,998,051 CHANGE IN NET ASSETS BEFORE CHANGE IN UNREALIZED APPRECIATION OF INVESTMENTS 20.60% 1,639,036 1.84% 656,448 CHANGE IN UNREALIZED APPRECIATION OF INVESTMENTS 4.08% 324,779 1.20% 428,159 CHANGE IN NET ASSETS 24.68% 1,963,815 3.04% 1,084,607 NET ASSETS — Beginning of year 91.51% 7,282,098 17.38% 6,197,491 NET ASSETS — End of year 116.19% 9,245,913 20.42% 7,282,098 10-19 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E 2007 2006 Part B Current Assets $2,360,882 $1,480,774 Current Ratio ----------------------- ------------------ ---------------- Current Liabilities $4,059,893 $3,851,715 = 0.58 0.38 Part C Cash + Short-term Investments $1,909,606 $1,044,193 Days Cash ----------------------------------------- ------------------ --------------- on Hand (Operating Expense - Deprec.)/365 $17,312 $95,885 = 110.31 10.89 Part D Total Debt $4,059,893 $3,851,715 Debt Ratio ----------------- --------------- --------------- Total Assets $13,305,806 $11,133,813 = 0.31 0.35 or Or 30.51% 34.59% Part E Total Debt $4,059,893 $3,851,715 Debt to Equity ---------------------- --------------- --------------- Total Net Assets $9,245,913 $7,282,098 = 0.44 0.53 or Or 43.91% 52.89% Part F Increase in Net Assets $1,963,815 $1,084,607 Total margin ----------------------------------- --------------- --------------- Total Operating Revenues $7,957,921 $35,654,499 = 0.25 0.03 or Or 24.68% 3.04% 10-20 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Part G Program Service Expense $6,053,675 $34,754,236 Program Services ----------------------------------- --------------- --------------- Total Expense $6,318,885 $34,998,051 = 0.96 0.99 or or 95.80% 99.30% 10-21 Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E Ratio analysis is a field that was developed primarily to serve for-profit organizations. Managers in public service organizations should be pro- active in developing additional useful ratios. For example, the not-for-profit industry in recent years has started to actively report the program services ratio.
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