PA 650 (WANG Chp 12) Financial Condition Analysis
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Financial Condition Analysis (FCA)
A thorough evaluation of the financial health of an organization.
Purpose of FCA
Identify the factors that impact financial condition and provide the recommendation to improve it.
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.
The process of specification of the analysis. Specification and testing of how a financial condition is affected by socioeconomic/organizational factors.
Also known as economic condition. Ability of and organization to meet its financial obligations.
Ability to pay. Four levels: cash, budget, long-run, service
The ability to generate sufficient cash to pay for current liabilities.
Cash Ratio and Quick Ratio
The ability to collect sufficient revenues to pay for expenditures or expenses.
Operating Ratio and Own Source Ratio
The ability to pay off long-term obligations.
Net Asset Ratio (Net Position Ratio) and Long Term Debt Ratio
The ability to financially support a desirable level of service.
Net Assets (Net Position) Per Capita and Long Term Debt Per Capita
A financial condition measure must assess a specified element of financial condition.
The elements used in formulation of a financial condition measure should be a consistent and objective.
The financial condition measure and supporting data should be affordable to obtain.
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.
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.
Total Revenues divided by Total Expenditures
Assesses the sufficiency of revenues to cover expenditures. A higher ratio indicates a better level of budgetary solvency.
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.
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.
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.
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.
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.
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.
Theoretical Justification of Measurement
A theoretical cause-effect relationship must be developed to indicate how a socioeconomic/organizational factor impacts financial condition.
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.
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.
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.
Interpretation of Correlation Coefficient Values
Correlation Coefficients have direction (+/-) and magnitude (weak/strong)
Correlation Coefficient = 0
Correlation Coefficient = Larger than 0 but smaller than 0.500
Weak Positive Relationship
Correlation Coefficient = 0.500 to 0.699
Moderate Positive Relationship
Correlation Coefficient = 0.700 to 0.999
Strong Positive Relationship
Correlation Coefficient = 1
Perfect Positive Relationship
Correlation Coefficient = Smaller than 0 but larger than -0.500
Weak Negative Relationship
Correlation Coefficient = -0.500 to -0.699
Moderate Negative Relationship
Correlation Coefficient = -0.700 to -0.999
Strong Negative Relationship
Correlation Coefficient = -1
Perfect Negative Relationship
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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