PA 650 (WANG Chp 12) Financial Condition Analysis

  1. Financial Condition Analysis (FCA)
    A thorough evaluation of the financial health of an organization.
  2. Purpose of FCA
    Identify the factors that impact financial condition and provide the recommendation to improve it.
  3. Scope of FCA
    The larger the scope the more analytically complex the FCA. Depends on the number of financial condition dimensions included in the analysis. Cash, budget, long-run and service solvency. Deciding how many to include will determine the scope.
  4. FCA Modeling
    The process of specification of the analysis. Specification and testing of how a financial condition is affected by socioeconomic/organizational factors.
  5. Financial Condition
    Also known as economic condition. Ability of and organization to meet its financial obligations.
  6. Solvency
    Ability to pay. Four levels: cash, budget, long-run, service
  7. Cash Solvency
    The ability to generate sufficient cash to pay for current liabilities.

    Cash Ratio and Quick Ratio
  8. Budgetary Solvency
    The ability to collect sufficient revenues to pay for expenditures or expenses.

    Operating Ratio and Own Source Ratio
  9. Long-run Solvency
    The ability to pay off long-term obligations.

    Net Asset Ratio (Net Position Ratio) and Long Term Debt Ratio
  10. Service Solvency
    The ability to financially support a desirable level of service.

    Net Assets (Net Position) Per Capita and Long Term Debt Per Capita
  11. Measurement Validity
    A financial condition measure must assess a specified element of financial condition.
  12. Measurement Reliability
    The elements used in formulation of a financial condition measure should be a consistent and objective.
  13. Measurement Affordability
    The financial condition measure and supporting data should be affordable to obtain.
  14. Cash Ratio
    Cash + Cash Equivalents + Marketable Securities divided by Current Liabilities

    Relates the extent of assets available to pay off current liabilities. The higher the ratio the better the cash solvency.
  15. Quick Ratio
    Cash + Cash Equivalents + Marketable Securities + Receivables divided by Current Liabilities

    Compared to Cash Ratio it is a more lenient measure because it includes non-cash assets. A higher ratio indicates a better level of cash solvency.
  16. Operating Ratio
    Total Revenues divided by Total Expenditures

    Assesses the sufficiency of revenues to cover expenditures. A higher ratio indicates a better level of budgetary solvency.
  17. Own-Source Ratio
    Revenues of Own Source divided by Total Revenues

    The level of revenue that comes from a government's own sources, such as taxes, charges, fees, and other revenues. These revenues are more stable and more controllable by the government than other source. A higher ratio indicates a better level of budgetary solvency.
  18. Net Asset Ratio
    Net Assets (Net Position) divided by Total Assets

    Assesses the extent of the government's ability to withstand financial emergencies during an economic slowdowns, the loss of major taxpayers, and natural disasters. A higher ratio indicates a better state of long run solvency.

    MODIFIED: Subtract Net Assets invested in capital Assets ... Because these capital assets may not be available to actually pay off long term obligations.
  19. Long-Term Debt Ratio
    Total Long Term Debt divided by Total Assets

    Assesses the ability to pay off its long-term debt. A higher ratio indicates a WORSE state of long run solvency.
  20. Net Assets (Net Position) Per Capita
    Net Assets divided by population

    Indicates the level of net assets in relation to population. A higher ratio indicates a better state of service solvency.
  21. Long-Term Debt Per Capita
    Total Long Term Debt divided by Population.

    Assesses the level of long term debt for each resident. A higher ratio indicates that the government carries more long term debt per capita and suggests a deteriorating state of service solvency.
  22. Socioeconomic/Organizational Factors
    These factors may influence the financial condition of the government. And should only be included if the measurement to be used can be justified and controlled.
  23. Theoretical Justification of Measurement
    A theoretical cause-effect relationship must be developed to indicate how a socioeconomic/organizational factor impacts financial condition.
  24. Measurement Controllability
    A measurement of socioeconomic/organizational factor is better if it is controllable; ie sensitive to policies or managerial operations or other human actions of the organization.
  25. Warning Trends
    After the measures of the financial condition are developed examine for any possible warning trend of deteriorating financial condition. Needs at least three periods of data to establish a warning trend. Exs may show downward trend or fluctuation - both require further examination.
  26. Correlation Coefficient
    To prove that a factor impacts financial condition, the factor and the financial condition must be related. Correlation Coefficient establishes the relationship and the strength of the relationship.
  27. Interpretation of Correlation Coefficient Values
    Correlation Coefficients have direction (+/-) and magnitude (weak/strong)
  28. Correlation Coefficient = 0
    No relationship
  29. Correlation Coefficient = Larger than 0 but smaller than 0.500
    Weak Positive Relationship
  30. Correlation Coefficient = 0.500 to 0.699
    Moderate Positive Relationship
  31. Correlation Coefficient = 0.700 to 0.999
    Strong Positive Relationship
  32. Correlation Coefficient = 1
    Perfect Positive Relationship
  33. Correlation Coefficient = Smaller than 0 but larger than -0.500
    Weak Negative Relationship
  34. Correlation Coefficient = -0.500 to -0.699
    Moderate Negative Relationship
  35. Correlation Coefficient = -0.700 to -0.999
    Strong Negative Relationship
  36. Correlation Coefficient = -1
    Perfect Negative Relationship
  37. Exact Form of Relationship
    The exact form of the relationship is not known or determined by the correlation coefficient. Ex: If population and revenues have a strong positive correlation we cannot determine but how much revenues will increase if population increases by 1000. Could further explore the form by examining per capita ratios.
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PA 650 (WANG Chp 12) Financial Condition Analysis
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