Spring 2013 issue of Horizons

institution’s overall size, making it possible to compare institutions with vastly differing amounts of available resources, and provides a measure of an institution’s liquidity. 2. Equity Ratio: This ratio is defined as modified net assets (or equity) divided by modified total assets. The equity ratio can be viewed as the proportion of an institution’s assets that are free of claims from outside parties. By considering the proportion of an institution’s assets that are considered to be expendable (i.e. not restricted), the department can more accurately assess the institution’s ability to borrow money and to finance capital purchases. 3. Net Income Ratio: Defined as the difference between unrestricted revenue and expenses and then divided by total unrestricted revenue, the net income ratio is viewed differently, depending on the type of institution. For for-profit entities, the ratio measures the profit earned (or loss incurred) by the institution during the year. For nonprofit entities, the ratio measures whether or not the institution operated within its means (as defined by the department) during the year. The department pays particular attention to this ratio, as it measures the direct effect of the institution’s yearly financial results on its balance sheet. After calculating each of the ratios, the department allocates different weights to each ratio (based on the department’s assessment of each ratio’s relative importance) and combines the final total for each calculation into one final composite score, which falls on a scale ranging from -1 to 3. Institutions that score between 1.5 and 3.0 are considered to be financially responsible and do not merit further department oversight. Institutions that score between 1.0 and 1.5 are considered to have failed

the test, but are allowed to continue participation in the Title IV programs under what is considered a “zone alternative,” which subjects the institution to some department oversight. Institutions with scores of less than 1 are not allowed to continue participation in the Title IV program without providing additional surety. Typically, institutions in this situation must obtain a letter of credit from a financial institution, guaranteeing a certain percentage of the institution’s Title IV funding. These letters of credit are typically costly and make it more difficult for the school to regain financial health. The requirement does not apply to public universities, however, as the department automatically considers any institution that has its liabilities backed by the full faith and credit of a state government to be financially responsible. After years of being utilized without significance by most private institutions, the financial responsibility test gained the entire industry’s attention in 2009 when more than 100 nonprofit institutions failed the department’s test.

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