Nonprofit Accounting Basics

Pre-Award Risk Assessments - Looking for Financial Sustainability

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.

Oct 16, 2018

Pre-award risk assessments are a relatively new phenomenon in the Federal Grants marketplace. Starting with the implementation of the Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards, §200.205 Federal Awarding Agency Review of Risk Posed by Applicants, introduced us to the concept. The general idea is that an agency should consider the risk posed by potential grantees to the success of the Federal program. These risks can be broken down into three broad categories:

  1. The ability of the grantee to properly account for Federal Awards;
  2. The ability to comply with the types of compliance requirements included in the Subpart D of the Uniform Guidance, Post Award Requirements
  3. The ability of the grantee to perform the services required by the Federal Award.

The third category is primarily focused on a grantee’s sustainability. Does the grantee have the financial capacity to meets is obligations during the period of performance and thereby meet its deliverables? The most significant risk you should consider is the financial capability of the organization that you intend to give Federal dollars to.

The absolute worst case scenario is that the organization you select cannot perform because of a lack of financial resources. The money is gone and you have no product or deliverable. In the case of poor accounting or noncompliance at least you have some recourse. That’s not the case if the organization fades from existence.

As a Federal Awardee or a pass through entity many of you are now in a position of having to select sub-grantees or sub-recipients. You have identified the three best candidates, all of which have the technical capacity to perform and perform well. The next step is to perform and document your assessment of risk associated with each candidate. Once this information is in hand, you can complete the selection process and move on to contracting with that organization.

As you are performing your risk assessments, make sure you ask for and receive the organizations most recent audited financial statements. If the organization can only provide audited financial statements from a past fiscal year look at the opinion date on the auditor’s report. This may give you some insight into the organizations audit cycle. If you are well beyond last year’s opinion date you should start to ask questions. It is possible that the organization has gone through some changes during the year, pushing back the audit. But it is more likely that the auditors have hit a snag. You need to know what these issues are before you agree to contract with that organization.

Let’s assume that you have received the audited financial statements. The question then becomes, how do I assess the financial capability of the organization? There are several metrics you should consider;

  1. Current ratio to current assets/current liabilities: a ratio less than 1 indicates that that the organization may have issues meeting its maturing obligations.
  2. Unrestricted net assets: You should always look at unrestricted net assets as an indicator of financial health, but you may want to also deduct the organizations interest in assets that are not liquid or are not easily convertible to cash. Unrestricted net assets – fixed assets – intangible assets. If you consider the result as a percentage of the organization’s annual expenditures it will provide you with insight into their operating reserves.
  3. Days cash expenditures on hand = Annual expenditures (adjusted for non-cash items such as depreciation expense) divided by 365 divided by (cash + accounts receivable): This is a key metric. You may want to divide daily expenditures by the sum of the organization’s liquid assets (cash) and those assets which will be converted into cash in a normal business cycle (accounts receivable). This is an excellent measure of the organization’s ability to absorb the loss of a funding stream or an unexpected event.
  4. Days cash expenditures on hand net of direct Federal Awards: This ratio is adjusted for grantees who may have the ability to draw down on a letter of credit or from PMS for direct Federal Awards. To calculate this ratio simply reduce annual expenditures by direct federal expenditures reported in organizations SEFA.

There are other ratios that can provide you with insight. In some cases you may want to use whatever makes the most sense for you. However, if you are new to financial management you can at least take comfort in knowing that these are the ones Rubino & Company uses when performing risk assessments of potential awardees on behalf of Federal agencies. 

What will this information tell you once you have calculated the ratios? It certainly will not tell you who the best choice is to perform the work. However, it will allow you to distinguish between organizations based on their financial capabilities. If two organizations are otherwise equal, it makes sense to select the one with the better financial outlook. At least you will be able to sleep a little better at night.