# Presentation: 293043

## Financial CapabilityReview(Financial Determination)

## Introduction

**Introduction**

**Cindi L. Brown, CPA**
- Special Reviews Branch
- 	Division of Financial Advisory Services,
- 	Office of Acquisition Management & Policy, OD, NIH
-  Please refer to our web page at the following URL  http://oamp.od.nih.gov/dfas.html

## What will you learn today?

- Why do a financial capability.
- When to do a financial capability review.
- How to perform a financial capability review.
- What do we do when a company appears not to have financial capability.
- Summary
- Answers to your questions.

## A Story

**Notes:**
Tell story.
Divide into two teams.
Hand out questions.  Give 5 minutes to complete
Someone keep score.
Handouts will be given in the end.
Question 1.

## Main Objective

- FAR 9.103
- FAR 9.104
- To make a determination as to whether the offeror has adequate financial resources or the ability to secure resources necessary to perform under the proposed project.

**Notes:**
Board reviews found that financial capability reviews were not being done.

FAR 9.103 states that contract shall be awarded to responsible prospective contractors only.
FAR 9.104-1(a) states the contractors must have adequate financial resources to perform the contract or have the ability to obtain them.

With contracts and some grants there is huge lag time between incurred costs and reimbursements.

## When and How

- The Special Reviews Branch (SRB) does a financial capability review for all cost analyses.
- The SRB provides reviews when requested.
- How we do a review depends on whether they are a University, Non-Profit, Hospital, or For-Profit.

**Notes:**
When do you do a financial capability review?

Even if you are not requesting SRB to do your cost analysis, you can request us to do your financial capability reviews.

Our request for services form is located on DFAS’ website under resources and links.

We get a lot of requests for doing financial capability reviews when grant specialists start the review and then discover a company appears not to have the financial capability. 

## What to consider

- For Universities, and Non-profit
-   Review the A-133 data collection form for going concern finding.
- The Federal Audit Clearinghouse at:  _[http://](http://harvester.census.gov/sac/)__[harvester.census.gov](http://harvester.census.gov/sac/)__[/sac/](http://harvester.census.gov/sac/)_

**Notes:**
Demonstrate how to search for a data collection form.

A-133 Audit is required for contractors and grantees with $500,000 more of expenditures of federal funds. 
If the auditor has substantial doubt if the company can continue to operate, they include an explanatory paragraph after in the opinion paragraph in the audit report.  The data collection form on page 2 has a going concern question; yes or no.

DFAS sees no reason not to rely on recent audit reports for financial capability. 
If there isn’t an audit on a non-profit company, then review them like a for-profit.

Let’s look at a data collection form at the Federal Audit Clearinghouse.

## Slide 8

## Slide 9

## Slide 10

## Slide 11

## Slide 12

## Slide 13

## Slide 14

## Slide 15

## What to Consider

- For Commercial/For-Profit Companies
- 	-  A negotiated rate agreement does _*not*_ equal a financial capability review.

**Notes:**
Just because a contractor has negotiated rates, don’t assume that they have financial capability.  

In the past, I’ve called DCAA (Defense Contract Audit Agency) and sometimes they can comment on company’s financial capability.

Also, DCA (Division of Cost Allocation), the agency who negotiates rate with Universities, Hospitals, and Non-Profits, does financial capability reviews.

So let’s start our review.
.

## How to perform a financial capability review

- Review the liquidity of the company.
- Request a copy of the offeror’s audited financial statements for the last two fiscal years.
- Calculate and analyze the _current_ (working capital) and the _quick_ ratios from the balance sheet to determine liquidity.

**Notes:**
Liquidity:  Can the company’s assets easily and quickly be converted to cash?
Most small companies will not have audited financial statements.  Small companies provide only a balance sheet.

Public companies will provide the URL for the location of their financial statements; SEC or their website.
SBIR grantees and contractors usually do not hire an accountant (costly), so they (scientists) attempt to compile a balance sheet.  Some small companies have a part-time bookkeeper.

## Financial RatiosCurrent or Working Capital

- _Current (Working Capital)_ is one of the most reliable measures of the liquidity of an organization.
- Working capital or current ratio is current assets divided by current liabilities.
- A ratio of 2:1 is highly desirable and a ratio of 1:1 or higher is satisfactory.

**Notes:**
$193,975 divided by $203,500 = .95:1

Sometimes I will see ratios higher that 2:1, but not often.  

I received a call one day asking me for sources of industry averages to compare the ratios to.

According to the AICPA, there are several sources of industry averages, but there are problems with using industry data.
Such as:  averages are not goals, just averages.
There are accounting differences within the industry.
There is a small sample of firms in industry.
There is a delay (at least eight months) in publication of industry rates.

We like to see 1:1.

We get really concerned when the quick ratio is less than 1:1.
Let’s go over some definitions.

## Current Assets & Liabilities?

- Current Assets must be capable of being converted into cash within a relatively short period without interfering with the normal operations of business.  The period of conversion varies with the nature of the business, but generally it is one year.
- Commonly seen current assets include cash, accounts receivable, inventory, prepaid expenses, and marketable securities.

## Current assets & liabilities?

- Current liabilities are debts that are to be paid by the use of current assets within the time period used to define current assets.
- Common current liabilities include notes payable, accounts payable, tax payable, wages payable, interest payable and unearned income.

## Financial RatiosQuick Assets or Acid Test Ratio

- Cash, plus receivables, plus marketable securities divided by current liabilities.
- This ratio serves a supplemental check and is indicative of the immediate liquidity of a company and its ability to pay immediate debts.
- A ratio of 1:1 or higher is considered adequate.  Less than 1:1 suggests potential cash flow problems.                   _[ ](file:///../Local%20Settings/Temporary%20Internet%20Files/Content.IE5/AJM3TLE6/balance%20sheet.xls)__[file](file:///../Local%20Settings/Temporary%20Internet%20Files/Content.IE5/AJM3TLE6/balance%20sheet.xls)_

**Notes:**
Current assets are listed in order of liquidity on the balance sheet.

Calculate ratios for two fiscal years; look for trends; better/worse?  When the ratios are low, I will request interim financial statements or a current balance sheet which is a snap shot of the company’s financial position.
A balance sheet is what I passed out to you.

## Notes to the Financial Statements

- Review the accompanying notes to the financial statements.
- Available line of credit?
- Parent Company providing financial support?
- Judgments, suits, or liens?

**Notes:**
In addition to calculating and analyzing ratio, read the notes.
You can find out a lot about the company in the notes.
Does the company have access to a line of credit with a financial institution?  
Line of credit can be a catch 22 since it increases current liabilities.
Has the parent company undertaken to provide financial support as necessary to enable the company to meet its liabilities as they fall due? 

Also, judgments, suites or liens are on the Dun & Bradsheet report which we will discuss shortly.

## Cash Flow Statement

- A cash flow statement shows the net increase or decrease in cash at the end of the year.
- Converts the financial statements from accrual to the cash basis.           _[file](file:///../Local%20Settings/Temporary%20Internet%20Files/Content.IE5/AJM3TLE6/Cash%20Flow%20Statement.doc)_

## Dun & Bradstreet (D&B)

- Financial risk
- Credit score
- Payment history
- Suits, liens, UCC
- Business background
- Key ratios – may not be current
- Can lack sufficient history
- Don’t rely alone on the D&B report

**Notes:**
D&B rates the financial stress class for the company; 1 to 5; 1 being a low risk.  This shows that during the previous year, firms with this classification had a failure rate of a certain percent and compares this to the national average.

Credit score predicts the likelihood of the company paying in a severely delinquent manner.

Also, the payment history shows if the company pays it’s bills slower than the national average.

Evident of open suits and liens are listed.

UCC is the Uniform Commercial Code.  Creditors file a form to become a secured creditor versus being an unsecured creditor in the event of bankruptcy.

I don’t always request a D&B; depends if I feel I have obtained enough information to determine if a company is financially capable.

Carolyn Pincus requests a comprehensive D&B report.  Needs Company name, address, point of contact, and phone number.

Many small and/or start up companies will not have a D&B report.

If the company doesn’t provide information to D&B, then there is insufficient information and we can’t rely on this report.  

Also, the D&B report may be based on information that is a few  years old.

## Questionable Financial Position

- Questionable financial position = no award? = not true!
-  Consider the type of funding mechanism.
- Consider the size of the contract or grant to determine risk.
- Current liabilities are not truly current (re-classify)
- Loans to owners, venture group, or shareholders.

**Notes:**
So the company appears not to have financial capability.  We don’t want to immediately exclude it from consideration of the grant or contract.  
	Unlike contracts, grants are intended to be a financial assistance mechanism.
	Size of the award should be considered.  What is the amount of risk which NIH can assume.  Is it a $100,000 SBIR grant or a $73 M contract? I would consider the chocolate contract to be a higher risk because of the amount.
	After analyzing the balance sheet and further discussions with the company, we find out that some current liabilities are long term since there is no intent to repay a debt within a year, therefore, the current liability should be re-classified.  The same current liability is reflected on the balance sheet for three years in a row.  That’s a clue.
	Also, if a loan is to an owner, it is highly unlikely that they would choose to satisfy these liabilities at the risk of the company’s ability to continue as a going concern.
	Subsequent events which improve the company’s financial position can occur after the financial statements have been audited.  Examples: sales of subsidiaries, segments or divisions, sales of expensive equipment, etc.

## Questionable Financial Position

- Remember – you can’t change the numbers!

**Notes:**
If they don’t appear to have adequate financial capability, you can’t change the numbers.

We are often hear “I must make this award” (kind of like my story about Out of the World Healthy Chocolate, Inc.).

If you award a contract even though you know they don’t have adequate financial capability, you are going to run into trouble.  We’ve seen this with accounting system reviews.

## Questionable Financial PositionWhat can you do?

- We recommend close monitoring of grantee/contractor.
- Consider restricting draw downs; cost reimbursement only.
- Recommend a review after three or six months after the award.
- Request a cash flow forecast for the first budgeted year of the contract.
- Recommend obtaining a line of credit.

**Notes:**
Excessive cash advances may indicate the company is using the funds  for non-contract/grant related expenditures.

Recommend a review after 3 or 6 months after award. 

## Questionable Financial Position

- Examples

## Summary

- Financial capability reviews are conducted during our cost analyses.
- SRB is available to do reviews for the grants and contracts communities at NIH.
- A company may not appear to have financial capability, but that doesn’t mean you can’t make an award.  Talk to them, investigate.

## Summary

- This is a fictitious story.  The characters are not based on actual people although there may appear to be similarities.
- And as far as I know it, no such miracle chocolate exists, but some people may think this is a dream come true.
- The chocolate I’ve handed out is not low-fat.  Proceed with caution.

## Questions