Transcript Financial Distress Strategy and Management

Financial Distress
Strategy and Management
Presented by:
Dr. Michael K. Townsley, Stevens Strategy
([email protected])
Dr. Debra M. Townsley, President, Nichols College
Susan K. Tellier, CPA
March 30,1 2010
NACUBO Webcast , Washington, DC
Financial Distress Agenda

Definition of Financial Distress

Financial Distress Conditions

Financial Distress Metrics and Tools

Financial Distress – Turnaround Strategies and Management

Long-Term Financial Management

Management Reporting

Case Study – Nichols College’s Turnaround

Takeaways



Measuring Financial Distress
Department of Education Scoring Index
Equilibrium Grid
3
Types of Financial Distress

Episodic Financial Distress is a temporary
lapse caused by deficits and happens when
unexpected changes take place in the market
or in government regulations or in purposeful
budgetary allocations.

Chronic Financial Distress is not a temporary
lapse into deficit spending but a continuous and
pervasive condition.
4
Financial Distress Conditions

Financial distress does not typically appear overnight.
Credit lines provide patchwork liquidity solutions, and the
credit lines are growing over time.

Lenders are reluctant to grant new loans or to revise

covenants.

Vendors, payroll tax withholdings, and payroll
benefit withholdings are not paid or forwarded

on time.
Proportion of student bills categorized as uncollectable

represent a growing proportion of receivables.
Deficits extend over a series of years.


Net assets have declined significantly over many years.
The Department of Education issues a letter requiring a
credit line to cover 50% of financial aid.
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Financial Distress Metrics
1.
Net from operations after deducting unrealized and
realized gains or losses has been negative for two or
more years and is growing in scale.
2.
The college is dependent on a credit line to cover
regular cash disbursement. Typical metrics for
evaluating cash adequacy are: the cash ratio of cash
to liabilities with a 0.50 benchmark and cash to
expenses with a 0.33 benchmark (about 3 months).
3.
Net assets are declining in scale. Set up a trend chart
to compare net assets.
4.
Working capital (current assets minus current liabilities)
is negative. Put together a simple working capital
chart to measure working capital. The net should be
zero or positive.
6
Financial Distress Metrics,
[Continued]
5.
The US Department of Education (DOE) Financial
Responsibility Index is less than 1.50. Track your DOE
scores using the DOE rules.
6.
The DOE penalty requires a letter of credit to
offset a portion of the federal funds.
7.
Composite Financial Index Score is less than
one (1.0).
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Financial Distress Tools with Examples
• Operating Net Adjustment for Unrealized & Realized Gains/Losses
Adjusted Operating Net ($000)
FY #1
Operating Net
$2,300
Deduct Unrealized & Realized Gains/Losses3,200
Adjusted Operating Net
($900)
FY #2
$1,800
2,200
($400)
FY #3
($3,000)
(1,500)
($1,500)
• Working Capital
Working Capital Example ($000)
Current Assets
Current Liabilities
Balance
Ratio
FY #1
$2,000
1,900
$100
1.05
FY #2
$1,750
2,100
($350)
0.83
FY #3
$1,500
2,200
($700)
0.68
• Cash Ratio
Cash Ratio ($000)
Cash and Short-Term Current Assets
Current Liabilities
Ratio
FY #1
$500
480
1.04
FY #2
$460
500
0.92
FY #3
$490
530
0.92
Benchmark
> 0.50
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Financial Distress Tool
Composite Financial Index (CFI)




The CFI combines four key ratios into a single
measure of financial condition.
The values of the four key ratios are combined
through a set of weights and factors to produce
the CFI score.
The CFI score is a broad measure of the state
of the institution.
It does not require comparison with a peer
group.
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Financial Distress Tool
Composite Financial Index

Scores are placed in a scaling range to indicate
degree of financial health.

Scores greater than three are strong indicators
of financial strength.

Scores of one or less suggest that the college
is in a fragile financial position.
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CFI Monitors Four Critical
Measures of Financial Risk

Primary Reserve Ratio measures operational risk
 Expendable net assets to expenses

Net Income Ratio measures short-term risk
 Net operating income to operating revenue

Return on Net Assets Ratio measures risk to
production of wealth
 Change in net assets to total assets

Viability Ratio measures long-term debt risk
 Expendable net assets to long-term debt
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Computing CFI Score with
Strength and Weights
Ratio Value
Primary
Reserve
Net Income Operations
Return on
Net Assets
Viabilirty
Ratio / Strength Factor Strength Value X Weight Ratio Scoring
X
Ratio / 0.1333
Strength *0.35 =
X
Ratio/ 0.0070
Strength * 0.10 =
X
Ratio / 0.0200
Strength * 0.2 =
X
Ratio / 0.4170
Strength * 0.35 =
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Financial Distress
CFI Scoring Guide
SCALE
LEVEL
CFI SCORING
RANGE
One
-1 to 1
Two
0 to 2
Three
1 to 3
Four
2 to 4
Five
3 to 5
Six
4 to 6
Seven
5 to 7
Eight
6 to 8
Experiment with new initiatives
Nine
7 to 9
Experiment with new initiatives;
achieve a robust mission
Ten
> 9
ACTION
Assess viability of
institution's survival
Reengineer the institution
Direct resources toward
transformation
Focus resources to compete
Deploy resources to achieve a
robust mission
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Financial Distress Tool
Department of Education (DOE)
Financial Responsibility Test


The purpose of the test determines if the
college has adequate financial resources.
Scoring Parameters are:


Score less that 1.5 and greater than 1.0 falls into
the zone of warning; results in a letter of
warning.
Scores less that 1.0; requires a line of credit for
50% of the financial amount available to be
awarded by college.
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Financial Distress Tool
Department of Education Index



Department of Education Ratios are:
 Primary Reserve (similar to CFI)
 Net Worth (net assets/total assets)
 Net Income (unrestricted net income /
unrestricted revenue).
Ratios are also adjusted by a set of strengths
and weights.
The strength and weight factors are on the
Department of Education site.
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Financial Distress
Turnaround Strategies
First Step: Collect financial, enrollment, and operational data.
Second Step: Determine the source(s) of financial distress:
1. Student markets.
2. Financial aid discounts
3. Shrinking value of gifts
4. Major declines in investments
5. Revenues growing faster than expenses
6. Check the components of the Composite Financial Index Ratios
to identify where problems exist.
Third Step: Estimate the gap between your current condition and financial
equilibrium.
Fourth Step: Develop specific plans based on the Second Step and the
scale of the gap identified in the Third Step.
Fifth Step: Put the plans into operation and carefully and continuously
monitor performance.
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Long-Term Financial Strategy
Goal: To reach long-term financial equilibrium.
Two Components of Equilibrium:
Cyert Equilibrium Model
• Equilibrium occurs when a college has adequate resources in
quality and quantity to support its mission.
• Equilibrium is reached by:
- Operating at or above breakeven;
- Maintaining the purchasing power of liquid assets; and
- Maintaining the quality of fixed assets.
• College must determine the scale of its equilibrium gap.
• Focus of strategy development should be to eliminate the gap
over time.
Hopkins and Massey Equilibrium Model
• Long-term growth rates for revenue equals or is greater than
long-term growth rates for expenses.
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Case Study
Nichols College

The turnaround strategy started in 1998, during
Debra Townsley and Sue Tellier’s first year at
the College.

What follows were the financial conditions at
Nichols College prior to and during the
turnaround.
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Enrollment from Turnaround to
Current Fiscal Year
Full-Time Undergraduates
1400
1200
1000
800
600
400
200
0
1998
1999
2000
2001
2002
2003
2004
Fall Semester
2005
2006
2007
2008
2009
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CFI Scores from Turnaround to
Current Fiscal Year
4.50
4.00
3.50
3.00
2.50
2.00
1.50
CFI Score
1.00
0.50
0.00
FY 1998 FY 1999 FY 2000 FY 2001 FY 2002 FY 2003 FY 2004 FY 2006 FY 2007 FY 2008 FY 2009
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What Was the CFI –
Turnaround Strategy

Our CFI was .43 in 1998, and is now about 3.20.

How was this turnaround accomplished?
Multi-faceted approach
 No sacred cows
 Communications essential

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Board Involvement—
Your First Priority
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Had 100% of the Board support.
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Rebuilt the Board, including the bylaws.
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Asked the Board to vote on tough issues.

Included more alumni on the Board.

Paid senior staff at market levels to get the best.
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Communications

Provide Fall/Spring open employee forums
with updates and Q&A session.

Offer a January State of the College
address.

Share financials with the College Community
(shared deficits with all in the first two years).
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Communications
[Continued]

During turnaround period, met with each
department as a group and with each faculty
member individually on where we’ve been,
where we’re at, where we’re going. (This has
been replaced by fall and spring College
meetings.)

Insisted that no employee speak about the
College closing to the students or the external
public and brought them to task if they did.
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Financial Planning

Did budget model in year one for five years –
critical for bond approval and for Board
approval – and noted the College would run a
deficit for up to four years. Therefore, the
College did not slash programs.

Continue to use and update the financial
planning model.

Planned by our motto: Under promise and
over achieve.
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Entrepreneurial Approach
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Acted and continue to operate entrepreneurially –
did not stand on academic tradition.

Attacked turnaround from all angles and hoped
something would work.
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Increased Revenue

Pursued new markets – CED, MBA, online.

Expanded undergraduate day enrollments.
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Offered new academic programs in hot fields.
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Raised tuition to level of the competition.
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Raised gifts –conducted a comprehensive campaign.
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Increased student retention.

Began summer programs.

Sold excess property.
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Decreased Expenses

Revised budgets and held staff to the amounts
assigned to their budgets.

Returned to core competencies – got out of golf
course management and faculty housing.

Closed nonperforming functions, like a
conference center.

Reorganized for efficiency, performance and
customer service – saved positions through
attrition.
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Decreased Expenses

Eliminated programs with low enrollments.

Offered early retirement incentive programs
(ERIPs) to faculty.

Adjusted faculty salaries so that they were
equitable.

Implemented post-tenure review and merit pay.
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Decreased Expenses

Used contracts (MA Higher Ed Contract Assoc.,
COWC Contracts, State Contracts).

Froze salaries – only equity adjustments.

Managed fringe benefits, including raising health
care employee contributions to a percentage so
employees share in future increases.

Developed a master plan with facility needs
which created long-run expense savings; we spent
money to do it right.
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Increased Net Assets

Shifted out of equity investments to fixed income;
subsequently, the College returned to an equity/fixed
income mix.

Set a policy: Half of cash surplus annually goes
into unrestricted net assets and half into physical
plant and deferred maintenance.

Issued bonds to build two buildings and to do
deferred maintenance without decreasing cash
on hand.
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Increased Net Assets
(expendable net assets)

Established a cash management program so that
money was not sitting in a checking account.

Paid off line of credit – paying 8% but earning 6%.

Negotiated with banks to get the best deal – now
with a local bank and get higher service and
lower cost, and we are a big customer to them.

Set a student collections plan to improve cash flow.
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Worked on “Curb Appeal”
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Refinanced old bonds at a lower rate to make
“curb appeal” improvements.
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Concentrated on improvements that would
improve the attractiveness of the College. (See
the following pictures of improvements in the
last ten years.)
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Old Residence Halls Replaced
Merrill Hall being taken down.
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Copper Beech I and II (Suite
Residence Halls)
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Academy Hall
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Conant Hall Exterior Renovations
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View of Campus Common
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Athletic Center
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Budleigh Hall
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Conrad Hall
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Nichols College Case Study
Summary

Turnarounds are possible, but not easy.

Most important factor is having Board
support.

Second most important factor is explaining
the problems and offering solutions.

Try many things. Some of them will work!
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Financial Distress Take
Aways

Department of Education and CFI References

CFI computation form

CFI Scoring sheet

Department of Education computation form

Cyert Equilibrium Grid

Hopkins and Massey Equilibrium Grid
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Department of Education and
CFI References

Department of Education References:
Ratios: http://www.ed.gov/finaid/prof/resources/finresp/finalreport/edlite-ratios1.html
Strength Factors: http://www.ed.gov/finaid/prof/resources/finresp/finalreport/edlite-strengths1.html
Weighting Factors; http://www.ed.gov/finaid/prof/resources/finresp/finalreport/edlite-weights.html
Score: http://www.ed.gov/finaid/prof/resources/finresp/finalreport/edlite-compositescore1.html

CFI Reference:
Strategic Financial Analysis for Higher Education, sixth
edition; KPMG; Prager, Sealy and Co,LLC; Bearing Point;
Washington DC; 2005
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Financial Distress Tool
Composite Financial Index (CFI)
PRIMARY RESERVE
add unrestricted net assets
add temporarily restricted net assets
subtract property, plant, equipment (net of depreciation)
add long-term debt
numerator = total expendable net assets
denominator = total expenses
Ratio =
NET INCOME USING UNRESTRICTED ASSETS
add unrestricted operating revenue
subtract unrestricted operating expenses
numerator = net operating income
add total unrestricted revenues and gains
add net assets released from restriction
denominator = total unrestricted operating income
Ratio =
RETURN ON NET ASSETS
numerator = change in net assets
denominator = total net assets (beginning of year)
Ratio =
VIABILITY
add unrestricted net assets
add temporarily restricted net assets
subtract property, plant, equipment (net of depreciation)
add long-term debt
numerator = expendable net assets
denominator = long-term debt
Ratio =
CFI SCORING (uses strengths and weight measures)
Primary Reserve
Net Income
Return on Net Assets
Viability
CFI Score
44
Financial Distress Tool Department of Education
(DOE) Financial Responsibility Index
1 PRIMARY RESERVE
add unrestricted net assets
add temoprarily restricted net assets
subtract property, plant, equipment (net of depreciation)
add long-term debt or bonds payable
subtract annuity, life income funds & term endowments
subtract goodwill
add post-employment & retirement liabilities
numerator = total expendable net assets
denominator = total unrestricted expenses
Ratio
2 EQUITY RATIO
total net assets
subtract goodwill
numerator = modified net assets
add total assets
subtract goodwill
denominator = modified assets
Ratio
3 NET INCOME RATIO
numerator = change in unrstricted net assets - audit
denominator = total unrestricted revenue
Ratio
4 STRENGTH and We ighting FACTORS
Primary Reserve Ratio
Equity Ratio
Net Income Ratio
6 DEPARTMENT OF EDUCATION SCORE
Ratio
Factor
Value
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Cyert Equilibrium Grid (with example)
Equilibrium Gap Analytic Grid
Detail Amounts
Total Gap
Deficit FY 2010
Operating Deficit
($3,000,000)
Deduct Realized & Unrealized Gains (Losses)
2,650,000
Gap Operations Net
(5,650,000) $
5,650,000
Cash Gap
Cash Balance FY 2009
250,000
Credit Line Loan FY 2009 - Last Quarter
1,500,000
Total
1,750,000
Inflation July 2008 - June 2009
Jun-09
214.537
Jan-09
210.328
CFI Growth
2.0%
Cash Gap
1,535,020
1,535,020
Fixed Asset Gap
Annual Depreciation
778,000
Inflation
2.0%
Maintenance Gap
793,569
793,569
TOTAL CYERT EQUILIBRIUM GAP
$ 7,978,589
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Hopkins Massey Revenue &
Expense Growth Rate Equilibrium Grid
(with example)

The Hopkins Massey method only accounts for deficits
and does not account for purchasing power nor
deferred maintenance.
Computation Components
FY #1
FY # 5
Compound Rate of Growth
Rate for Equilibrium
Total Revenue for Equilibrium
Additional Dollars Needed
Check on Percent Increase
Revenue ($000)
$25,000,000
$27,600,000
2.5%
-7.5%
$33,436,510
$5,237,838
7.5%
Expenses ($000)
$24,300,000
$33,250,000
-7.5%
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