Performance Evaluation for Government and Not for Profit Organizations |CPA Exam FAR

This page covers analysis not for profit organizations including Ratio Analysis such as program expense ratio and service efforts and accomplishments.

Performance Evaluation for Not-for-Profit Organizations

Government Performance Evaluation: Ratios

Service Efforts and Accomplishments (SEA) Reporting

Service Efforts and Accomplishments Reporting

Governmental financial statements, notes, and required supplementary information meet many of the needs of citizens, creditors, and oversight authorities. Similarly, the financial statements of private not-for-profits are useful to donors, government regulators, and creditors. However, neither governmental nor not-for-profit financial statements are particularly effective in measuring organizational effectiveness. The fundamental problem is that government and not-for-profit effectiveness cannot be expressed solely in financial terms. Effectiveness in nonbusiness organizations must be measured in terms of the quality of the service provided or the extent to which an organization fulfills its mission. For this reason, many governments and not-for-profits report nonfinancial information in addition to their financial statements. The framework for combining financial and nonfinancial information to more effectively communicate organizational effectiveness is termed Service Efforts and Accomplishments (SEA) reporting.

GASB Concepts Statement 2, Service Efforts and Accomplishments Reporting, was issued in 1994. In addition, a series of research reports related to colleges and universities, economic development programs, elementary and secondary page 389education, fire department programs, hospitals, mass transit, police department programs, public assistance programs, public health, road maintenance, sanitation collection and disposal, water and wastewater treatment, and other activities has been issued. A summary research report includes chapters for each of these areas. At this time GASB has issued no standards for SEA reporting and it is therefore voluntary.

federal and state governments.

EVALUATING PERFORMANCE

Our attention to this point in the text has been on the preparation of financial statements by state and local governments and a variety of not-for-profit organizations. Now we will focus on the use of financial and nonfinancial information in evaluating the performance and financial position of not-for-profit organizations and governments. When organizations vary greatly in size, it is difficult to evaluate their relative performance based on gross amounts reported in the financial statements. To facilitate comparisons, many users of financial statements calculate ratios. We describe commonly used ratios in the following sections.

Analysis of Not-for-Profit Organization Financial Statements

The most commonly used measure of not-for-profit efficiency is the program expense ratio. This is calculated as program service expenses divided by total expenses and provides an indication of the extent to which a not-for-profit is dedicating its resources to programs as opposed to administration, fund-raising, and membership development. The program expense ratio may be calculated from the Statement of Activities or from information reported in the Form 990.

Fund-raising efficiency is another measure of performance that expresses how much an organization spends in raising a dollar of donations. The fund-raising efficiency ratio is calculated as fund-raising expense divided by contribution revenues. Generally membership development is combined with fund-raising expenses. The fund-raising efficiency ratio for the Performing Arts Organization is > $.05, calculated as ($1,292 + $1,152)/$50,303. The interpretation is that the organization spends less than five cents to raise a dollar of contributions.

Working capital ratio is the ratio of working capital (current assets – current liabilities) divided by total expenses. The ratio provides a measure of how long a not-for-profit could sustain its operations without generating new revenue. Entities with high working capital ratios would be less likely to eliminate programs or staff during periods of economic downturn.

Analysis of State and Local Government Financial Statements

Financial statements are intended to provide information useful in making decisions. In the commercial sector, creditors and investors use financial information to make lending and investment decisions. Donors compare the financial statements of not-for-profits to determine where to contribute money. Similarly, state and local government financial statements are intended to be useful for decision making. However, the information needs of users of governmental reports are more varied than those of private sector organizations. There are at least three distinct groups of users of government financial information: (1) citizens/voters, (2) investors and creditors, and (3) legislative and oversight officials.

Citizens use financial information to monitor the actions of elected officials and to determine where to buy a home or locate a business. Voters use information about government performance in selecting their elected officials and to determine whether to support bond issues or tax referenda. Before lending money or purchasing bonds, creditors and investors use financial information to evaluate the creditworthiness of governments. State governments use financial information to evaluate compliance with the conditions of grants issued to local governments. As we have seen, the federal government requires audited financial statements of state and local governments receiving federal funds.

Part of the reason that government financial reports are so complex is that these different user groups have different information needs. GASB has addressed the varying information needs by designing comprehensive financial reports that provide both fund-basis and government-wide statements and by requiring supplemental information. However, this complexity also makes it more page 387difficult to locate and use financial information. In some cases, financial statement users obtain their information directly from government financial reports. In other cases, they rely on intermediaries, which act as a conduit for information. Newspapers, as well as television and radio news programs, report financial information about governments and reach audiences that have never examined financial statements or budget documents. Interest groups and political parties also collect and distribute financial information, although their reporting may be selective and self-serving.

The most established information intermediaries exist in the public finance marketplace. Often described as the municipal bond market, participants include issuers, underwriters, financial advisors, and rating agencies, all of whom serve as information intermediaries. Debt-rating services, such as Moody’s and Standard & Poor’s, assist investors by rating bonds and other forms of debt. Rating agencies examine a host of financial, economic, and demographic factors and condense the information into a single measure that reflects the overall creditworthiness of a government bond. Moody’s rates bonds (highest to lowest) as Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C. Governments are keenly interested in their bond rating, since lower ratings translate into higher borrowing costs.

Ratio Analysis To assist citizens in understanding government financial reports, GASB has issued a series of user guides. What You Should Know about Your Local Government’s Finances: A Guide to Financial Statements (2011) is a plain-language explanation of local government financial reports. Illustrative financial statements are provided with annotated boxes explaining the meaning of key items. Similar guides are available for school districts (2012) and business-type activities (2013). In addition, GASB publishes a more detailed Analyst’s Guide to Government Financial Statements (2012). The analyst’s guide provides a discussion of common financial ratios useful in evaluating governments.

Financial ratios are used to convert information to a more understandable form. The most straightforward form of ratio analysis is common size analysis. In common size analysis, all items on a financial statement are scaled, typically by the largest amount appearing on that statement. Specifically, items on balance sheets are divided by total assets, and items appearing on operating statements are commonly divided by total revenues. For example, capital assets for the Village of Riverside represent nearly 94 percent of the Village’s total assets.

Simply calculating ratios is not sufficient to provide insight. Ratios must be compared to something to be useful in making evaluations and judgments. This year’s financial ratios are compared to previous years’ to identify trends. Even more useful is comparing ratios among various governments. For example, by comparing the Village of Riverside’s ratios to those of other villages in the region, we may be able to determine whether the Village’s financial condition is strong or weak relative to page 388its peers. Since all governments follow the same set of generally accepted accounting principles, comparisons among governments are valid.

In contrast to accounting principles, there is no generally accepted set of financial ratios, and sometimes there is disagreement on how to compute a given ratio. GASB’s Analyst’s Guide to Government Financial Statements identifies four categories of financial ratios and provides examples within each category. The four categories represent measures intended to assess different characteristics of a government and include financial position, liquidity, solvency, and ability to pay The interpretation column explains what the ratio is intended to reveal and whether larger or smaller values are preferred. For purposes of illustration, assume the Village has a population of 10,000 and assessed value of property of $100 million.

Ratios may be computed from the government-wide statements using only the governmental activities column, business-type activities column, or in total (using the primary government column). Alternatively, ratios may be computed separately for governmental-type funds or even for the individual fund. Clearly some ratios require information from particular statements. For example, leverage measures necessarily come from the government-wide statements since long-term liabilities do not appear in the governmental-type funds. Debt service coverage can only be directly measured from proprietary fund statements since cash flow statements are not prepared for governmental funds or at the government-wide level. The choice of ratios to compute and the level of reporting (government-wide or fund-basis) is determined by the purpose of the analysis. However, comparisons are valid only if the ratios and computations are consistent across fiscal years and across governments.

Service Efforts and Accomplishments Reporting

Governmental financial statements, notes, and required supplementary information meet many of the needs of citizens, creditors, and oversight authorities. Similarly, the financial statements of private not-for-profits are useful to donors, government regulators, and creditors. However, neither governmental nor not-for-profit financial statements are particularly effective in measuring organizational effectiveness. The fundamental problem is that government and not-for-profit effectiveness cannot be expressed solely in financial terms. Effectiveness in nonbusiness organizations must be measured in terms of the quality of the service provided or the extent to which an organization fulfills its mission. For this reason, many governments and not-for-profits report nonfinancial information in addition to their financial statements. The framework for combining financial and nonfinancial information to more effectively communicate organizational effectiveness is termed Service Efforts and Accomplishments (SEA) reporting.

GASB Concepts Statement 2, Service Efforts and Accomplishments Reporting, was issued in 1994. In addition, a series of research reports related to colleges and universities, economic development programs, elementary and secondary page 389education, fire department programs, hospitals, mass transit, police department programs, public assistance programs, public health, road maintenance, sanitation collection and disposal, water and wastewater treatment, and other activities has been issued. A summary research report includes chapters for each of these areas. At this time GASB has issued no standards for SEA reporting and it is therefore voluntary.

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SEA Measures Service efforts are measures of costs and other resources dedicated to a program or service. For example, consider the service of police protection. Direct costs include salaries and benefits for police officers who are directly engaged in crime prevention, detection, and apprehension of offenders. To the extent that the costs are separately identifiable, vehicle and equipment costs are directly allocated. Indirect costs of the police department may also be allocated from general government expenditures. Inputs may also include nonfinancial measures such as number of personnel and hours expended.

Service accomplishments include outputs and outcomes. According to the GASB, output measures are the quantity of a service provided or the quantity of a service that meets a certain quality requirement. Examples of output measures for a police department include number of responses, number of arrests, and the hours of patrol. Output measures should be distinguished from measures of outcome. Outcomes measure the extent to which results are achieved or needs are met at least partially due to the services provided. Examples of outcome measures are the number of violent crimes committed, the value of property lost due to crime, and response time.

Efficiency measures relate costs and other inputs to output measures, such as the number of responses per dollar spent or per police officer. Cost-outcome measures relate inputs to outcomes, such as the value of property lost to crime per dollar spent.

A variety of measures should be presented. Those measures should be reported consistently, in a timely manner, and in a way that is easily understood. Comparisons with prior periods and with other governments are also useful. Explanatory variables, such as socioeconomic data, should be included to help readers understand that not all the results are controllable.

Some cautions are in order regarding SEA reporting. Until standards are developed and commonly reported and used, there is a risk that governments will present only that information that is favorable. Audit opinions are not associated with this information, and it is unlikely they will be for some time. Challenges exist in the measurement and allocations of costs, not to mention the measurement of outputs and outcomes. Even with the problems, however, SEA reporting is viewed by many as essential for measuring the performance of a government or an activity of a government. SEA measures are now a part of the budget process of many governments. Standardization and public reporting would make the SEA measures more useful.