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62834 Federal Register / Vol. 62, No.

227 / Tuesday, November 25, 1997 / Rules and Regulations

Each step of calculating the composite Step 1: Financial Ratios between the sectors. The values of the
score under the ratio methodology is ratios are determined from information
illustrated in Appendices F and G of The methodology employs three ratios contained in an institution’s audited
these regulations and discussed more that measure the same elements of financial statement and are generically
fully in the following sections. financial health but are customized to defined as follows:
reflect the accounting differences For proprietary institutions:

Adjusted Equity
Primary Reserve ratio =
Total Expenses
Modified Equity
Equity ratio =
Modified Assets
Income Before Taxes
Net Income ratio =
Total Revenues

For private non-profit institutions:

Expendable Net Assets


Primary Reserve ratio =
Total Expenses
Modified Net Assets
Equity Ratio =
Modified Assets
Change in Unrestricted Net Assets
Net Income ratio =
Total Unrestricted Revenues

A detailed description of the to assist the Department and KPMG in profitability or ability to operate within
components of the numerators and developing the ratio methodology. its means and is one of the primary
denominators of the ratios is provided The Primary Reserve ratio provides a indicators of the underlying causes of a
under Appendix F of these regulations measure of an institution’s expendable change in an institution’s financial
for proprietary institutions and under or liquid resource base in relation to its condition.
Appendix G for private non-profit overall operating size. It is, in effect, a A more thorough description of the
institutions. measure of the institution’s margin ratios is provided under part 4 of the
In view of the public comment and against adversity. The Primary Reserve Analysis of Comments and Changes.
the empirical work performed by ratio measures whether an institution
KPMG, the Secretary selected these has financial resources sufficient to Step 2: Strength Factor Scores
ratios because together they take into support its mission—that is, whether The strength factor score reflects the
account the total financial resources of the institution has (1) sufficient degree to which an institution
an institution and provide broad financial reserves to meet current and demonstrates strength or weakness in
measures of the following fundamental future operating commitments, and (2) the fundamental elements as measured
elements of financial health: sufficient flexibility in those reserves to by the ratios. That strength or weakness
1. Financial viability: The ability of an meet changes in its programs, is assigned a point value of not less than
institution to continue to achieve its educational activities, and spending negative 1.0 nor more than positive 3.0,
operating objectives and fulfill its patterns. Thus, the Primary Reserve where a negative 1.0 indicates a relative
mission over the long-term; ratio provides a measure of two of the weakness in the fundamental elements
2. Profitability: Whether an institution fundamental elements of financial and a positive 3.0 indicates relative
receives more or less than it spends health—financial viability and liquidity. strength in those elements. The point
The Equity ratio provides a measure
during its fiscal year; values are assigned by a linear algorithm
of the amount of total resources that are
3. Liquidity: The ability of an (equation) developed for each ratio.
financed by owners’ investments,
institution to satisfy its short-term contributions or accumulated earnings, For example, the linear algorithm for
obligations with existing assets; depending on the type of institution, or calculating the strength factor score for
4. Ability to borrow: The ability of an stated another way, the amount of an the Equity ratio of a proprietary
institution to assume additional debt; institution’s assets that are subject to institution is ‘‘6 X Equity ratio result.’’
and claims of third parties. Thus, the ratio A proprietary institution with an Equity
5. Capital resources: An institution’s captures an institution’s overall ratio equal to ¥0.167 would have a
financial and physical capital base that capitalization structure, and by strength factor score of negative 1.0 (6
supports its operations. inference its ability to borrow. With X ¥0.167=¥1.002).
In identifying these fundamental respect to the fundamental elements of The linear algorithms developed for
elements, the Secretary relied on financial health, the Equity ratio each ratio are contained in Appendix F
KPMG’s extensive experience in measures capital resources, ability to for proprietary institutions and
analyzing the financial condition of borrow, and financial viability. Appendix G for private non-profit
postsecondary institutions and the work The Net Income ratio provides a institutions. The algorithms are
of the community task force assembled direct measure of an institution’s explained in greater detail under Part 6

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