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Financial Statement Analysis: The Basics for Non-Accountants

• 15 Aug 2019

What is one thing that creditors, investors, management, and regulatory authorities all have in common? In order to do their job well, all of them rely in one way or another on financial statement analysis.

Creditors rely on financial statements to evaluate whether a company or organization will be able to pay back a debt. Regulatory authorities, like the US Securities and Exchange Commission (SEC), rely on financial statements to determine whether a company meets the accounting standards required of a publicly traded company. Investors rely on financial statements in order to understand whether investing in a company would be profitable. And management relies on financial statements to make intelligent business decisions and communicate with investors and key stakeholders.

“Accounting is the language of business , and a company’s financial statements are its way of communicating accounting information to its owners and the taxing government,” says Thomas R. Ittelson, author of Financial Statement: A Step-by-Step Guide to Understanding and Creating Financial Reports and Visual Guide to Financial Statements: Overview for Non-Financial Managers & Investors . “This includes sales, costs, expenses, profits, and assets.”

Simply put, the business world could not exist in its current form without financial statements.

But what is financial statement analysis? What are the most common types of financial statements? And how do you conduct an analysis? Learn more about this fundamental business skill below.

What is Financial Statement Analysis?

Financial statement analysis is the process an individual goes through to analyze a company’s various financial documents in order to make an informed decision about that business.

While the specific data contained within each financial statement will vary from company to company, each of these documents is designed to offer insight into the health of the company. They are also essential to monitoring a company’s performance over time, as well as understanding how a company is progressing toward key strategic initiatives.

At its heart, says Ittelson, financial statement analysis allows an individual to “watch where the money, goods, and services go.”

Related: Finance vs. Accounting: What's the Difference?

Common Types of Financial Statements

Companies will often produce a number of financial statements, each of which is tailored to the needs of a particular audience. The information contained in each of these documents will vary by necessity.

The most common types of financial statements that you may encounter include: Balance sheets, income statements, cash flow statements, and statements of shareholder equity.

1. Balance Sheets

A balance sheet is designed to communicate the “book value” of a company. It’s a simple accounting of all of the company’s assets, liabilities, and shareholders’ equity, and offers analysts a quick snapshot of how a company is performing and expects to perform.

Most balance sheets follow this basic formula:

Assets = Liabilities + Shareholders’ Equity

An asset is anything the company owns which has a quantifiable value. This may include physical property (vehicles, real estate, unsold inventory, etc.), as well as non-physical property (patents, trademarks, etc.).

Liabilities refer to money the company owes to a debtor. This may include outstanding payroll expenses, debt payments, rent and utility payments, money owed to suppliers, taxes, bonds payable, and more.

Shareholders’ equity is a term that generally refers to the net worth of a company. It reflects the amount of money that would be left if all assets were sold and all liabilities paid. This money belongs to the shareholders, whether they are a private owner or public investors.

2. Income Statements

An income statement is a report that a company generates in order to communicate how much money it has earned over a period of time. They’re often found as quarterly and annual reports.

In addition to communicating top-line revenue, income statements detail a number of other metrics that can be helpful to analysts and investors. These include:

• Operating expenses, which detail every expense the company encountered during the reporting period
• Depreciation, which quantifies the extent to which a company’s assets (for example, aging equipment or vehicles) have lost value over time
• Net income, which subtracts the company’s expenses from its gross revenue in order to determine its total level of profits or loss
• Earnings per share (EPS), which divides net income by the total number of outstanding shares

3. Cash Flow Statement

A cash flow statement is a report that details how a company receives and spends its cash. These are also called cash inflows and outflows.

A company can only operate as long as it has the money to cover its expenses. Cash flow reflects a company’s ability to operate in both the short- and the long-term, and is used by investors, creditors, and regulators to determine whether a company is in good financial standing.

Cash flow statements are typically split into three sections:

• Operating activities, which details cash flow generated from the company delivering upon its goods or services, including both revenue and expenses
• Investing activities, which details cash flow generated from the buying or selling of assets, such as real estate, vehicles, and equipment (using free cash and not debt)
• Financing activities, which details cash flow from both debt and equity financing

4. Statement of Shareholders’ Equity

The statement of shareholders’ equity is a financial statement that details changes in the equity held by shareholders, whether those shareholders be public or private investors.

A statement of shareholders’ equity will typically report changes in the number of shares and value of common and preferred stock , as well as details about whether or not the company has purchased back any stock previously held by shareholders (called treasury stock ) and other data points.

5. Management’s Discussion and Analysis (MD&A)

The MD&A is a document written by the company’s management, which is designed to accompany financial reports.

While it is not a financial document in and of itself, an MD&A will typically provide additional context about why the company performed the way that it did during the reporting period, which can be incredibly helpful to investors, analysts, and creditors.

According to the SEC , “The purpose of MD&A is to provide investors with information that the company’s management believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations. It is intended to help investors to see the company through the eyes of management.”

While an MD&A should always be taken with a grain of salt, the Sarbanes-Oxley Act of 2002 mandates that senior corporate officers personally certify in writing that the company's financial statements comply with SEC disclosure requirements and fairly present, in all material aspects, the operations and financial condition of the issuer.

“Officers who sign off on financial statements that they know to be inaccurate will go to jail (if and when caught),” Ittelson says.

How to Conduct Financial Statement Analysis

Typically, professionals will follow one of two common methods to analyze a company’s financial statements: Vertical and horizontal analysis, and ratio analysis.

Vertical and Horizontal Analysis

Vertical and horizontal analysis are two related, but different, techniques used to analyze financial statements. They each refer to the way in which a financial statement is read, and the comparisons that an analyst can draw from that reading. Both types of analysis are critical to gaining an accurate understanding of the information provided in a financial statement.

• Vertical analysis is the process of reading down a single column in a financial statement. Whereas horizontal analysis is used to identify trends over time, vertical analysis is used to determine how individual line items in a statement relate to another item in the report. For example, in an income statement, each line item might be listed as a percentage of gross sales.

• Horizontal analysis, on the other hand, refers to the process of reading current financial data in comparison to previous reporting periods. Also called “trend analysis,” reading a financial statement in this way allows an individual to see how different financial metrics have changed over time: For example, whether liabilities have increased or decreased from Q1 to Q2.

Ratio Analysis

Ratio analysis is the process of analyzing the information in a financial report as it relates to another piece of information in the same report.

There are many different kinds of ratios which can help you gain insight into the health of a company. These are generally broken into the following broad categories:

• Profitability Ratios: These ratios offer insight into how profitable a company is. Some important profitability ratios include gross profit ratio, return on equity, break-even point, return on equity, and return on net assets.
• Liquidity Ratios: Liquidity ratios offer insight into how liquid a company is, which is important in measuring a company’s ability to stay in business. Some important liquidity ratios include cash coverage ratio, current ratio, and liquidity index.
• Leverage Ratios: Leverage ratios offer insight into how much a company is dependent on debt to maintain its operations. Some important leverage ratios include debt to equity ratio, debt service coverage ratio, and fixed charge coverage.
• Activity Ratios: Activity ratios offer insight into how well a company is utilizing resources. Some important activity ratios include accounts payable turnover rate, accounts receivable turnover rate, inventory turnover rate, and working capital turnover rate.

Once you have calculated a ratio for the current period, you can compare it against previous periods to understand how the company is performing over time. It’s also possible to compare the ratio against industry standards to understand if the company in question is under- or over-performing.

Learning the Skills You Need for Success

If you want to learn how to perform financial statement analysis, either for your own interest or to better perform the duties of your job, a number of options can help you gain the skills you need.

You could pursue a self-taught route, reviewing publicly available financial statements in order to familiarize yourself with the way that financial data is typically presented. Paired with mentorship opportunities at your organization, this can be a great way of learning the basics, but it isn’t your only option.

Taking an online class focused on finance or financial accounting are other potential paths you can take to gain the skills you need.

Do you want to take your career to the next level? Download our free Guide to Advancing Your Career with Essential Business Skills to learn how enhancing your business knowledge can help you make an impact on your organization and be competitive in the job market.

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1.4: Financial Statement Analysis

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Financial Statement Analysis: “How Are We Doing?”

Financial statement analysis informs a wide variety of strategic management questions, including:

• What is this organization’s overall financial position? Is it liquid? Profitable? Solvent?
• How does this organization’s financial position compare to its peer organizations?
• How can this organization adjust its operations and policies to strengthen its financial position?
• How much debt or other long-term liabilities can this organization afford?

On March 22, 2014 the side of a hill near the town of Oso, Washington gave out after three days of relentless rainfall. A massive landslide followed, with mud and debris covering more than a square mile. Forty-three people were killed when their homes were engulfed by the slide.

In the days that followed more than 600 personnel participated in search and recovery operations. They rescued eight people from the mud and evacuated more than 100 others to safety. Most of the rescue personnel came from the four rural Snohomish County fire districts that surround Oso.

Minutes after hearing of the slide, staff at the Washington State Office of Financial Management (OFM) – the governor’s budget office – made two critical phone calls. Earlier that week they had reviewed some data on the financial health of local special districts across the state. They observed that rural fire districts in the counties north of greater Seattle were showing signs of acute fiscal stress. Those districts had seen huge growth in property tax collections during the real estate boom of the 2000’s. But since the real estate crisis of 2007-2009, those revenues had fallen precipitously. Many of those districts had laid off staff, cut back on specialized training, and back-filled shifts with volunteer firefighters.

So moments after hearing of the slide, OFM staff called the fire chiefs at two of the most financially-stressed Snohomish County fire districts. Their message to those chiefs was simple: send your people. OFM agreed to reimburse the districts from state or federal emergency management funds if needed. In turn, personnel from two of those districts were among the first on the scene, and were responsible for three of the eight life-saving rescues.

A few weeks later the chiefs of both those districts acknowledged that had OFM not called, they would not have sent their personnel. Both districts were so financially stressed that they could not have afforded the overtime wages and other expenses they’d have incurred to participate in the rescue operations.

Financial condition matters. It shapes how a public organization thinks about its mission and its capabilities. In the case of the Oso mudslide, it was the focal point for some life-saving decisions. That’s why all aspiring public servants need to know how to evaluate financial statements, and to measure, manage, and improve their organization’s financial position.

Learning Objectives

After reading this chapter, you should be able to:

• Compute and interpret ratios that describe liquidity, profitability, and solvency.
• Contrast how those ratios mean slightly different things across the government, non-profit, and for-profit sectors.
• Compute the “Ten Point Test” for governments.
• Understand the typical strategies organizations employ to improve their liquidity, profitability, and solvency.
• Contrast short-term solvency with long-term solvency, particularly for governments.

What is Financial Position?

Financial position is a public organization’s ability to accomplish its mission now and in the future. When stakeholders ask “how are we doing, financially?” the answer should reflect that organization’s financial position.

An organization’s financial position has three main components:

• Liquidity. Does the organization have liquid resources – especially cash – to cover its near-term liabilities? Can it convert its less liquid assets to cash to cover those liabilities?
• Profitability. Do the organization’s revenues cover its operating expenses?
• Solvency. Can the organization generate enough resources to cover its near-term and long-term liabilities?

Till Debt Do Us Part Some say there are two types of non-profits: “Those that have debt, and those that don’t.” This is a powerful sentiment. It suggests that once a non-profit has taken on debt, none of its other stakeholders matter. If that organization encounters significant financial stress and cannot repay its creditor(s), then those creditors have a legal claim to its assets. In that circumstance, that organization’s board, clients, funders, and others will have little recourse, and the mission will suffer.

In the previous chapter you learned how to extract information about an organization’s financial position from its balance sheet. For example are most of its assets liquid (e.g., cash and marketable securities), or does it have assets that are more difficult to convert to cash (e.g., receivables, inventory, or prepaid expenses)?

The balance sheet also tells us a lot about solvency, namely if the organization has a lot of long-term liabilities (e.g., long-term debt or pension obligations). Long-term liabilities mean the organization will have to divert some of its resources to meet those liabilities, and that can mean fewer resources to invest in its mission. To be clear, there are times when an organization can and should take on long-term liabilities in pursuit of its mission. Sometimes it makes sense to borrow and invest in a new facility that allows the organization to effectively serve its clients. Pensions and retiree health care benefits are an important employee recruitment and retention tool, even though they result in a long-term liability.

To learn about profitability we typically look to the income statement. Recall that if an organization’s revenues exceed its expenses, then its net assets will grow. The income statement makes clear the organization’s major sources of revenues, which revenues are growing, and whether those revenues cover program and administrative expenses. On the income statement, we can also see depreciation, bad debt expenses, and other expenses that reduce net assets but don’t necessarily impact cash. These are all profitability concerns.

While financial ratios can provide us with useful metrics, always start off with a quick review of the financial statements. Ideally, the financial statements you are working with should report on the organization’s operating and financial position for at least two financial periods. Keep in mind that funding agencies and financial analysts often would need access to at least four if not five years of financial data.

What do the financial statements tell you about the organization’s financial position? Operating results? Cash flows? Review the financial statements and take note of the changes in assets, liabilities, revenues and expenses. Carefully review the notes to the financial statements as they will provide you with more detailed information regarding the organization’s financial position. For example, a note related to fixed assets will report fixed assets at historical cost, assets subject to depreciation, any additions or retired assets, annual depreciation expense as well as accumulated depreciation, and ending balance as reported in the balance sheet. A note for pledges receivable will report amounts due in one year (or current portion), amounts due more than one year but less than five years, and amounts due more than five years. The note will also detail bad debt expense and the discount factor used to find the present value of non-current pledges receivable. A review of the trends should inform your interpretation of the ratios.

A review of the Statement of Financial Position (or Balance Sheet) can be guided by the following questions:

• Assets : How have the assets changed? What proportion is current? How much is reported under cash and cash equivalents? How much is reported under property plant and equipment, net of depreciation? Were there any new investments in property plant and equipment (review notes related to fixed assets)? How much is reported under investments? What proportion of investments is restricted? Have investments changed significantly and was this the result of market gains and investment income, a capital campaign, or transfers from cash (review note on investments)? How much more or less is the organization reporting in receivables/prepaid expenses? Have changes in current assets had a negative or positive impact on cash flows (also review Cash Flow Statement)?
• Liabilities : How have the liabilities changed? What proportion of liabilities is the result of borrowing or financing activities? To assess long-term solvency, what proportion of liabilities are reported as long-term debt obligations? Are there any covenants or restrictions associated with these obligations? To assess short-term solvency, what proportion of liabilities are current? Of that, how much is in the form of a short-term loan or a line of credit? Are there any contingent liabilities reported in the notes to the financial statements?
• Net Assets : What proportion is reported as unrestricted? Of restricted net assets, what proportion is reported as permanently restricted?

Your review of the Income Statement can be guided by similar questions:

• Revenues : What are the major sources of revenues? Have there been significant changes in revenues? Of total revenues, what percent is unrestricted, restricted (i.e., temporarily versus permanently)? How much of the organization’s revenue is driven by earned income activities? Is the organization susceptible to changes in policy or funding priorities of a governmental agency?
• Expenses : How much did the organization spend on programs? How much did the organization spend on administration? Fundraising? Have there been significant changes in the level of spending? Have personnel costs changed? Are there other fixed costs that limit budget flexibility? How much did the organization report in depreciation and amortization?

Financial Statement Ratios

The purpose of accounting is to help organizations make better financial decisions. Financial statement analysis is the process of analyzing an organization’s financial statements to produce new information to inform those decisions. Public organizations make dozens of crucial decisions everyday: Should we expand a program? Should we lease or buy a new building? Should we move cash into longer-term investments? Should we take a new grant from a local government?

All of these decisions must be informed by financial statement analysis. An organization should not expand if its existing programs are not profitable. It should buy a new building only if it knows how its current rent and other operating expenses contribute or detract from its profitability. It should move cash into less liquid investments only if it knows how much liquid resources it needs to cover its operating expenses? And so on. To answer these questions with precision, we need good metrics that illustrate an organization’s liquidity, profitability, and solvency.

For those metrics, we turn to financial ratios (sometimes called financial statement ratios ). Financial ratios are calculations derived from the financial statements. Each ratio illustrates one dimension of an organization’s overall financial health.

Analysts who evaluate public organizations’ financial statements employ dozens of different financial ratios. The first table lists a set of liquidity ratios. Liquidity ratios speak to the composition of an organization’s assets, and how quickly those assets can be deployed to cover the organization’s day-to-day expenses. The numerator in these ratios is a measure of liquid resources — either current assets or a specific type of current asset (cash and cash equivalents, receivables etc). The denominator in these ratios is either current liabilities or a measure of average daily cash expenses. For the latter, we take total expenses and remove expenses like depreciation, amortization, and bad debt expense that do not require an outflow of liquid resources. This adjusted for spending number is divided by 365 to produce a rough measure of average daily spending.

Profitability ratios are derived from changes in net assets. Recall that net assets increase when revenues exceed expenditures. This is an intuitive measure of profitability. The operating margin speaks to profitability in the organization’s basic (i.e., unrestricted) operations. Net asset growth is a more inclusive measure of profitability across the entire organization. Net asset growth will include changes in temporarily restricted and permanently restricted net assets that are not included in the operating margin.

Margin (sometimes called the profit margin) is the price at which a good or service is sold, minus the unit cost. Industries like retail clothing have extraordinarily tight margins, meaning the price exceeds unit cost by just a percent or two. Low margin businesses must be “high volume,” meaning they must sell a lot of product to be profitable. Professional services like accounting, tax consulting, and equipment leasing are “high margin,” meaning the price charged exceeds the unit cost by a lot, sometimes by orders of magnitude. High margin industries tend to have barriers to entry. They require highly-trained professionals, expensive equipment, and other significant up-front investments.

Profitability measures are less salient for governments because governments need not be profitable to continue operating. Unlike a non-profit or for-profit, a government can bolster its financial position by raising taxes or fees. Most governments don’t have wide latitude to that effect, but they have more than other organizations. That’s why profitability measures for government are focused both on growth in net assets, but also on the share of total revenue that’s derived from revenue sources the government can control on its own, like general revenues and capital grants.

The solvency measures speak to where the organization gets its resources. If it depends too much on unpredictable or volatile revenues from donors, that’s a potential solvency concern. The same is true of revenues from governments. Government revenues can disappear quickly if the government changes its own fiscal policies and priorities. Debt, although sometimes necessary, indicates a drain on future resources. All these factors can inhibit an organization’s ability to continue to serve its mission.

The Internal Revenue Service (IRS) monitors the contributions ratio as part of its public support test for charitable organizations. According to this test, a non-profit must receive at least 10% of its support from contributions from the general public and/or from gross receipts from activities related to its tax-exempt purposes. Less than that suggests the public is not invested in that organization’s mission. By contrast, non-profit analysts also emphasize the tipping point where a non-profit depends too much on individual donors. Different analysts define the tipping point threshold differently, but most agree that 80% of total revenues from individual contributions is dangerously high. At that point, a non-profit’s ability to serve its mission is far too dependent on unpredictable individual donors, and not dependent enough on corporate, foundation, and government support.

For governments, the solvency ratios are focused entirely on debt and other long-term obligations. Governments can borrow money that won’t be paid back for decades. If careless, a government can take on too much leverage. That’s why these solvency ratios focus on how much money a government has borrowed in both its governmental and enterprise funds, and its ability to pay back that debt. The later is known as coverage . Bond investors, particularly for public utilities, often stipulate how much coverage a government must maintain at all times. Coverage ratios are usually expressed as operating revenues as a percentage of interest expenses.

In addition to financial health, financial statements can illuminate how efficiently a non-profit raises money and how much of its resources it devotes to its core mission. These effectiveness measures are related to, but separate from financial position. Fundraising efficiency shows the financial return a non-profit realizes for its investments in fundraising capacity.

The program expense ratio is one of the most closely-watched and controversial ratios in non-profit financial management. It tells us how much of a non-profit’s total expenses are invested in its programs and services, rather than administration, fundraising, and other overhead spending. Many analysts and non-profit monitors recommend a program service ratio of at least 80%.

Ratios and Rules of Thumb

These rules of thumb are derived from the rich academic literature and industry analysis of public organizations. To be clear, there is no legal or GAAP-based definition of “financially healthy,” or “strong financial position.” Every foundation, donor, or grantor defines these metrics differently. They’ll also vary across different type and size of organizations. The rules listed in this table are some of the common figures cited by across many analysts in the public and private sector.

Before going further let’s consider a few key points about financial statement ratios:

• Ratios are only part of the story. Ratios are useful because they help us quickly and efficiently focus our attention on the most critical parts of an organization’s financial position. In that sense they’re are a bit like watching on ESPN the thirty-second highlight recap of a football game (or whatever sporting event, if any, you find interesting). If we want to know which team won, and who made some big plays, we’ll watch the highlight reel. If we want to know the full story – the coaches’ overall game plan, which players played well throughout the game, when a key mistake changed the course of the game, etc. – we need to watch a lot more than just the highlights. Ratios are the same way. They’re fast, interesting, and important. If we want a quick overview and not much more, they’re useful. If we don’t have the time to dig deeper into an organization’s operations, or if it’s not appropriate for us to dig deeper, then they’re the best tool we have. But they’re never the whole story. Always keep this limitation in mind.
• Always interpret ratios in context. Ratios are useful because they help identify trends in an organization’s financial behavior. Is its profitability improving? How has its overall liquidity changed over time? Are its revenues growing? And so on. But on their own, ratios don’t tell us anything about trends. To reveal a trend, we must put a ratio in context. We need to compare it to that same ratio for that same organization over time. For that reason we often need multiple years of financial data. It’s also essential to put ratios in an industry context. Sometimes, a broader financial trend will affect many organizations in similar ways. A decline in corporate giving will mean lower donor revenues for many non-profits. Increases in overall health care costs will impact all organizations’ income statements. Reductions in certain federal and state grants will affect particular types of non-profits in similar ways. To understand these trends we need to compare an organizations’ financial ratios to the ratios of organizations in similar industries. It’s useful, for instance, to compare human services-focused non-profits with less than $2 million in assets to other small, human-service focused non-profits in the same region with less than $2 million in assets. We should compare fee-for-service revenue-based non-profits to other fee-for-service revenue-based non-profits to other fee-for-service revenue-based non-profits. Large non-profits with a national or international mission should be compared to each other. There are clear rules about defining comparable organizations. The only rule is that without context, an analysis doesn’t tell us much.
• Financial statement analysis raises questions. A good financial statement analysis will almost always reveal some contradictory trends. Why does this organization’s profitability look strong but the current ratio is well below the rule of thumb? Why is this organization less liquid than its peers? Why does this organization not have debt, and is far more liquid, than similar organizations? A good financial statement analysis raises many of these types granular questions about the organization’s financial assumptions, program operations, and overall effectiveness. Sometimes these follow-up questions can be answered from other publicly-available information, such as the notes to the financial statements or the annual report. Sometimes they can’t. If your analysis concludes with many unanswered questions, that does not mean your analysis is bad. It simply means there are limits to what we can learn from financial statements alone.
• Ratios are retrospective. Most organizations release their financial statements three to six months after the close of their fiscal year. Analysis based on those statements is relying on information that is at least 12 to 18 months old. A lot can happen in 18 months. Always keep this in mind when doing financial statement analysis.

What’s Your Industry?

Financial analysts in the for-profit sector focus on financial trends within the industry sectors defined by the North American Industry Classification System or NAICS. These codes identify businesses by key aspects of their operations. For instance, according to recent estimates, there are just over 72,000 businesses in the US within NAICS code 152101 – “Single-family home remodeling, additions, and repairs.” The National Center for Charitable Statistics has developed an analog classification scheme for non-profits known as the National Taxonomy of Exempt Entities (NTEE). NTEE is not as precise or specific as the NAICS, but it is a useful way to think about sub-sectors within the non-profit sector.

Non-Profit Financial Ratios – An Illustration

To see these ratios in action let’s return to Treehouse. The table below shows its computations for the key financial ratios from its FY15 financial statements. All the information for these computations is taken from Treehouse’s basic financial statements included in the previous chapter.

We can summarize Treehouse’s financial position as strong. Each of its ratios are at or better than their benchmarks. It’s profitable, it has a robust and effective fundraising operation that produces 70% of its total revenues, it does not have debt, and it depends minimally on government revenues. [1] These are all markers of a strong financial position. Its contributions ratio suggests that going forward it should seek to diversify some of its revenues away from donations. Perhaps not surprisingly, its program service ratio is .79, almost exactly the .8 rule of thumb.

Treehouse is also quite liquid. Its current ratio suggests its current assets could cover its current liabilities almost 15 times over, and its quick ratio suggests its most liquid resources alone could cover those liabilities more than 11 times over. It also has just above the recommended days of liquid net assets and days of cash on hand. So in other words, it does not keep a startling amount of cash, but it is highly liquid. Nonprofits that depend on pledges often see precisely this dynamic. If an organization depends on pledges then it will in turn book a lot of pledges receivable that will roll in throughout the year. Those receivables are liquid resources, but they’re not necessarily cash, that’s available to spend. And since most of Treehouse’s expenses are for salaries and other near-term spending, it carries few if any current liabilities. That combination of high receivables and low current liabilities can make Treehouse look more liquid than it is, especially given its modest cash holdings.

The “Ten Point Test” – An Illustration

Throughout the past few decades, analysts have developed a popular framework to evaluate local governments’ financial condition. It’s known as the “ Ten Point Test .” It’s comprised of ten key ratios that, when taken together, summarize a government’s liquidity, profitability, and solvency. In the Ten Point Test framework a government earns “points” based on how its ratios compare to its peer governments. If its ratios are consistently better than its peers it earns a higher score. If its ratios are consistently worse than its peers, it’s scores are lower and in some instance negative.

To see the Test at work let’s return to Overland Park, KS. The table below shows the Ten Point Test ratios and their computations based on its FY2015 financial statements. To compute these ratios yourself refer back to OP’s basic financial statements included in the previous chapter. [2]

OP ratios look good overall. It has plenty of liquidity. Its short-run financial position (i.e. it’s “fund balance ratio”) is 29%, well above the rule of thumb. It also has more than enough cash to cover its general fund current liabilities. Its net assets are growing, only six percent of its operating revenues are from sources it does not control, it has few near-term liabilities [3] , and its “operating margin” (i.e. the extent to which it relies on taxes, rather than user charges to cover its operating expenses) of 0.61 is positive. For these reasons it’s no surprise that Overland Park maintains the highest possible “AAA” rating from two major credit rating agencies – Moody’s and Standard & Poor’s.

Fortunately, the Ten Point Test framework allows us to go a step further. Instead of asking how OP compares to generic benchmarks, we have the tools to compare OP to its peer local governments. This allows us to make much more precise statements about OP’s current and future financial position.

Analysts typically do these peer comparisons by computing the Ten Point Test ratios for a variety of local governments, and then assigning point values based on relative rankings. For example, to compute OP’s Ten Point test score for FY 2015, refer to the table below. This table shows national trends for these same ratios. These trends are based on data from the financial statements of 3,721 city governments and 1,282 county governments from FY2005-2015. [4] The ratios are presented in quartiles. Recall that a quartile is a group of percentiles, and a percentile identifies a point in the distribution of that ratio. The table is organized by population groups. So for instance, for cities with populations between 100,000 and 250,000 (OP’s peer group) the 25th percentile for short-run financial position was 8%. That means one-quarter of OP’s peer cities had short-run financial position less than 8%, and three-quarters had short-run financial position equal to or greater 8%. For all the ratios shown here the first quartile starts at the lowest ratio and ends at the 25th percentile, the second quartile covers the 25th percentile through the 50th percentile, and the third quartile covers the 50th percentile through the 75th percentile. The fourth quartile includes all observations above the 75th percentile.

These quartiles are the basis for the Ten Point Test scoring. If a local government is in the second quartile for a ratio, its score for that ratio is zero. It is not qualitatively better or worse than its peers, so that ratio does not help or hurt its relative score. If a ratio is in the third quartile it earns one point. The logic here is that a ratio above the median (i.e. the 50th percentile) is a financial positive for that government. If a ratio is in the fourth quartile it earns two points. To land in the fourth quartile, a government is better than most of its peers on that particular ratio, and that indicates a source of financial strength. By contrast, a ratio in the first quartile means that government is comparatively weak on that dimension of financial health. To reflect that weakness, we subtract one point.

A local government’s overall Ten Point Test score is easy to interpret. Analysts generally use the following categories:

• A score of 10 or greater suggests a government’s financial position is “among the best.” It can easily meet its immediate spending needs, it has more-than-adequate reserves to mitigate the immediate effects of recessions, natural disasters, or other unexpected events, and it has the capacity to generate adequate resources to cover its long-term spending needs. To earn that score most of its ten ratios must be as good as or better than its peer governments.
• A score between 5 and 9 means the government is “better than most.” Most of its ratios are better than its peer governments, and a few ratios are equal to its peers.
• A score between 1 to 4 means the government is “average.” Most of its ratios are equal to, or weaker than its peer governments.
• A score between 0 and -4 means the government is “worse than most.” Most of its ratios are weaker than its peer governments.
• A score less than -5 means the government is “among the worst.” It has major financial problems and may be insolvent. Scores this low are quite rare.

Let’s return to OP, to compute its Ten Point Test Score. Recall that OP’s population in FY2015 was 187,730, so we’ll use the “Population 100,000 to 250,000” quartiles.

As we saw above, OP’s liquidity is strong. It scores in the top quartile for both short-run financial position and liquidity. It’s profitability ratios are also acceptable, but not nearly as strong as its liquidity. It was in the first quartile for net asset growth, and the third quartile for own-source revenues. These two ratios reflect the same underlying fact: OP depends mostly on general taxes like sales taxes and property taxes, and depends little on user charges and fees or on outside grants or other support. That’s why its own-source revenue is comparatively high, but its operating margin is comparatively low.

OP’s solvency profile is mixed. It has virtually no current liabilities in its governmental funds, and virtually no long-term debt in its proprietary funds. That’s why its near-term solvency and coverage 2 ratios, respectively, are both in the top quartile. At the same time, it is quite leveraged. That fact is reflected in its comparatively high debt burden and its comparatively low coverage 1 ratio. It also appears that in 2015 OP’s investment in capital assets was comparatively low, despite its comparatively high leverage.

Taken together, OP’s ratios add up to an overall Ten Point Test score of seven. Its main financial strengths are its liquidity and its near-term solvency. At the same time, its higher than average debt load and dependence on general revenue sources, lowered that score. Recall that a score of seven suggests OP is “better than most” similarly-sized local governments.

With this overall framework you can compute and interpret a Ten Point Test score for virtually any local government.

Financial Position and Financial Strategy

Financial statement analysis can tell us a lot about an organization’s financial position. The question, then, is what to do about it? As mentioned, sometimes financial statement analysis implies some clear follow-up questions about an organization’s financial operations and overall performance. Ideally, it also suggests some steps that management can take to improve that financial position and performance.

The table below identifies some of those potential steps. It is organized around liquidity, profitability, and solvency. Plus signs identify that part of the organization’s financial position that is strong. Minus signs suggests a potential weakness. There is no “textbook” definition of a financial strength or weakness. However, most public sector analysts define ratios above the benchmark rule of thumb or above the median within a peer group as strong, and ratios below the benchmark rule of thumb or below the median within a peer group as weak. This is not a comprehensive list, but it does illustrate some basic management strategies that tend to follow from different patterns of financial position.

For example, the top right box lists strategies appropriate for a non-profit with good liquidity and good profitability, but concerns about solvency. An organization with these characteristics has enough resources on hand and is currently able to generate enough resources to cover its expenses. What’s less clear is whether it can continue that trend into the future. Perhaps it is too dependent on donor revenues or government grants. Maybe it delivers a service that no one will want in the future. Maybe it has had to borrow a lot of money to build out its service delivery capacity. Regardless of what’s driving the solvency concerns, it’s clear this organization has a good, profitable business. The challenge is ensuring it has enough demand for its services to support its ongoing operations.

To that end, an organization with these characteristics could consider investing in additional capital equipment or facilities that might help it expand its client or customer base. It might also expand or extend its programs to include new lines of business that will allow it to tap into new clients/customers. If long-term liabilities are part of the solvency concern it could consider restructuring or re-negotiating those liabilities.

“Scrubbing” Your Expenses

To “scrub” expenses is to carefully review all current major spending items for potential cost savings. Some contemporary examples include:

• Transition bills to online payments and save on transaction costs and timing delays associated with processing paper bills.
• Move employee reimbursements from checks to direct payroll deposits.
• Renegotiate premiums with your health insurance provider. Bundle different insurance policies with one carrier to improve economies of scale.
• Hire a human resources consultant to identify appropriate salary ranges for future salary negotiations and collective bargaining.
• Shift from traditional phone service to a “voice over internet” (VOI) system. VOI generally offers more lines and better reliability at a lower cost.
• Move to a “multi-platform” plan with your wireless/cellular communications provider. Save money by running phones, iPads, and other wireless devices on one plan.
• Negotiate with credit card providers for lower annual percentage rates and transaction fees.
• Consider opening a line of credit with your existing financial institution. Some institutions offer discounts for bundling banking with credit services.
• Negotiate better terms with your credit card payment processing company. Consider investing in an online processing system that does not require you to lease or purchase credit card terminals
• Move from local servers to a cloud-based, server-less computing environment.
• Explore “software as a service” for typical business applications.

Each of these tactics should happen only after careful attention to costs associated with disrupting the organization.

Contrast this with an organization that has concerns about liquidity, but is otherwise profitable and solvent. This is a good example of a “profitable but cash poor” organization. Here the challenge is to convert some of that profitability into a stronger base of liquid resources. To that end, an organization under these circumstances could consider some short-term borrowing to better manage its cash flow. This might weaken its solvency a bit, but that might be a necessary trade-off relative to weak liquidity. It might also make a specific ask to donors for a reserve fund or other financial contingency fund to bolster its liquidity.

Of course, organizations with concerns about all three aspects of financial position might consider more drastic measures like a merger with another non-profit.

In short, these strategies are some of the most typical for organizations with different financial position profiles.

CASE: JONAS COMMUNITY CENTER

THE JONAS COMMUNITY CENTER, INC.

AUDITED FINANCIAL STATEMENTS

JUNE 30, 2015 AND 2014

NOTES TO FINANCIAL STATEMENTS

Note 1. Organization The Jonas Community Center, Inc. (the “Center”) is a Washington not-for-profit corporation. The Center provides comprehensive services, including emotional and substance abuse counseling, HIV/AIDS education and prevention, residential treatment and neighborhood center services to residents of central Washington.

The Center’s wholly owned subsidiary, Jonas Social Enterprises, Inc., is a taxable entity created in 2005. It is engaged in construction remodeling, repair, and maintenance, employing individuals who have been served by the Center’s programs.

Note 2. Summary of Significant Accounting Policies The accompanying consolidated financial statements include the accounts and activities of the Center and its wholly-owned subsidiary. All intercompany balances and transactions have been eliminated in consolidation.

Net assets and revenues, gains and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, net assets and changes therein are classified as follows:

Temporarily restricted net assets – Net assets subject to donor-imposed stipulations that may or may not be met by actions of the Center and/or the passage of time Unrestricted net assets – Net assets not subject to donor-imposed stipulations

Grants and other contributions are reported as temporarily restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the consolidated statement of activities as net assets released from restrictions. Temporarily restricted support is reported as unrestricted if the donor restrictions are met in the same reporting period. At June 30, 2015, temporarily restricted net assets are subject to time restrictions.

Management uses estimates and assumptions in preparing financial statements in accordance with accounting principles generally accepted in the United States of America. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were used.

Property, plant, and equipment are stated at cost or, if donated, at the estimated market value at the date of donation, and are depreciated on a straight-line basis over their estimated useful lives.

Intangible assets are recorded at costs and amortized on the straight-line method over periods ranging from three to seven years.

The Center is exempt from income taxes under Section 501(c)(3) of the Internal Revenue Code. Accordingly, no provision for income taxes is required. Donors may deduct contributions made to the Center within the Internal Revenue Code regulations. There are no unrecognized tax benefits and income tax returns remain subject to examination by major tax jurisdictions for the standard three-year statute of limitations.

The costs of providing the various programs and other activities have been summarized on a functional basis in the statement of activities. Accordingly, certain costs have been allocated among the programs and supporting services benefitted.

A number of unpaid volunteers have made contributions of their time to develop and operate the Center’s programs. The value of this contributed time is not reflected in the financial statements since the Center does not have a clearly measurable basis for the amount to be recorded.

Certain reclassifications have been made to the 2014 financial statements in order to conform them to the 2015 presentation.

Note 3. Accounts Receivable

Accounts Receivable are stated net of an allowance for doubtful accounts of $7,500 at both June 30, 2015, and 2014.

Note 4. Property, Plant, and Equipment

Property, Plant, and Equipment consist of:

Intangible Assets consist of:

Note 6. Notes Payable

Note 7. Long-Term Debt

Note 7. Long-Term Debt (cont.) Following are maturities of long-term debt for each of the next five years and in the aggregate:

Interest expense incurred on all corporate obligations totaled $210,183 in 2015 and $204,664 in 2014. Interest paid totaled $208,822 in 2015 and $198,450 in 2014.

The mortgage note payable above includes provisions requiring the Center to maintain certain restrictive financial covenants. At June 30, 2015, all covenants were met by the Center.

Note 8. Operating Leases

The Center leases real estate, motor vehicles, and office equipment under operating leases expiring at various intervals through 2018. The following is a summary of future minimum rental payments required under these leases as of June 30, 2015 for each of the next three years:

Rental payments made under leases with remaining terms in excess of one year totaled $158,111 in 2015 and $147,042 in 2014.

Note 9. Concentration

The Center received a substantial amount of its support and revenue from the State of Washington. If a significant reduction in the level of this support and revenue were to occur, it may have an effect on the Center’s programs and activities.

The Center also has financial instruments, consisting primarily of cash, which potentially expose the Center to concentrations of credit and market risk. Cash is held at a local bank. The Center has not experienced any losses on its cash and cash equivalents. In the ordinary course of business, the Center has, at various times, cash deposits with a bank which are in excess of federally insured limits.

Note 10. Retirement Plans

The Center maintains a qualified contributory retirement plan under Section 403(b) of the Internal Revenue Code for all employees meeting certain age and service requirements. The Center contributes at a rate equal to fifty percent of the elective deferrals of each employee on the first $2,000 of contributions. The Center’s contribution totaled $27,142 for 2015 and $22,846 for 2014.

Note 11. Liability to the State of Washington

In 2013, the Organization recorded a liability of $28,352 to the State of Washington for non-reimbursable costs in excess of available offsetting revenue. The amount is reported in Other Liabilities in the accompanying balance sheet.

Note 12. Related Party

Included in Notes Payable and Long-Term Debt are amounts due to members of management and the Board of Directors. Amounts due under these arrangements totaled $4,665 and $11,064 at June 30, 2015 and 2014, respectively.

The Center, as a tenant-at-will, rents a facility from a member of its Board of Directors. Rent expense incurred under this arrangement totaled $43,800 in 2015 and $42,000 in 2014.

• A number of members of the Board believe Jonas Community Center (JCC) is profitable but not solvent. Others argue the nonprofit is solvent, but not profitable. Do you agree with either position? What evidence supports your argument.
• Identify three things – two in the next six months and another in the next two years – that JCC could implement to address one or more of the issues you have identified from your review of the financial statements.

CASE: THE SAFE HOUSE

THE SAFE HOUSE

JUNE 30, 2016 AND 2015

THE SAFE HOUSE, INC.

• NATURE OF ACTIVITIES

The Safe House (the Organization) is a nonprofit human service agency that assists families in crisis by providing a foundation of hope for victims of domestic violence. Serving a diverse community made homeless by domestic violence, the Organization works to eliminate the core causes through program services and community education. Assistance includes housing, advocacy, information and referral services, community education, and other specially designed services in support of the Organization’s programs. These services include emergency food, clothing and transportation, youth programs, and support groups. The Organization’s programs are supported primarily through contributions and government grants. Government grants from two agencies represent 28% and 32% of total support and revenue for the years ended June 30, 2016 and 2015, respectively.

The Organization’s programs are as follows:

Emergency Services: Each year approximately 300 survivors stay at the Organization’s emergency shelter an average of eight weeks. It is confidentially located and can house up to 40 survivors and their children at one time. The shelter is a safe and comfortable environment where women and children can access the resources necessary to help build a violence free life.

Transitional Housing Services: The Organization operates a scattered housing transitional program. Up to 22 women are assisted through housing and ongoing advocacy for a period of up 24 months.

Youth Program: The youth program provides advocacy, safety planning and developmentally appropriate activities for emergency shelter residents under 18 years of age.

Community Education: The Safe House maintains a commitment to education and raising awareness in the community about the effects of domestic violence. Through outreach and educational programs, the Organization educates high school and middle school students on the warning signs of intimate partner violence as well as their rights within all relationships. The Organization is also committed to raising awareness about domestic violence in the workplace so businesses and employees know their rights if they or someone they know is experiencing intimate partner violence.

Response Advocacy Program: The Safe House has three advocates out-stationed at the police bureau. These advocates work specifically with survivors involved with some level of the criminal justice system. Two of these work collaboratively with other community partners through the Domestic Violence Enhanced Response Team (DVERT) working toward victim safety for high risk and high lethality domestic violence situations.

• SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: Net assets and all balances and transactions are presented based on the existence or absence of donor-imposed restrictions. Accordingly, the net assets of the Organization and changes therein are classified and reported as unrestricted or restricted net assets. Unrestricted net assets are those that are not subject to donor-imposed stipulations. Temporarily restricted net assets are subject to donor-imposed stipulations that will be met, either by actions of the Organization and/or the passage of time.

Cash and Cash Equivalents: For purposes of the statement of cash flows, the Organization considers all highly liquid investments available for current use with maturities of three months or less at the time of purchase to be cash equivalents.

Investments: Investments are carried at fair value. At June 30, 2015 investments consisted of various certificates of deposit held in a CDARS (Certificate of Deposit Account Registry Service) account.

Accounts Receivable: Accounts receivable are reported at the amount management expects to collect on balances outstanding at year-end. Based on management’s assessment of the outstanding balances, it has concluded that realization losses on balances outstanding at year-end will be immaterial.

Property and Equipment: Acquisitions of property and equipment of $500 or greater are capitalized. Property and equipment purchased are recorded at cost. Donated assets are reflected as contributions at their estimated values on the date received.

Depreciation: Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets which range from 5 to 15 years for equipment and 40 years for buildings.

Income Tax Status: The Organization is a nonprofit corporation exempt from federal and state income tax under section 501(c)(3) of the Internal Revenue Code and applicable state law. However, income from rental activities not directly related to the Organization’s tax exempt purpose is subject to taxation. No provision for income taxes is made in the accompanying financial statements, as the Organization currently has no net income subject to unrelated business income tax. The Organization is not a private foundation.

Restricted and Unrestricted Revenue and Support: Contributions, which include unconditional promises to give (pledges), are recognized as revenues in the period the Organization is notified of the commitment. Conditional promises to give are not recognized until they become unconditional, that is when the conditions on which they depend are substantially met. Management provides for probable uncollectible amounts for pledges receivable through a charge to expense and a credit to a valuation allowance based on its assessment of the current status of individual accounts. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts and pledges receivable.

Contributions received are recorded as unrestricted, temporarily restricted, or permanently restricted support, depending on the existence and/or nature of any donor restrictions. Donor-restricted support is reported as an increase in temporarily or permanently restricted net assets, depending on the nature of the restriction. When a restriction expires (that is, when a stipulated time restriction ends or purpose restriction is accomplished), temporarily restricted net assets are reclassified to unrestricted net assets and reported in the statement of activities as net assets released from restrictions.

Government grants and contracts are recognized as revenue when the services are performed.

Special event fees and sponsorships are recognized in the period the event is held. Funds received in advance are reflected as deferred revenue.

Donated Facilities, Materials, and Services: Donations of property, equipment, materials and other assets are recorded as support at their estimated fair value at the date of donation. Such donations are reported as unrestricted support unless the donor has restricted the donated asset to a specific purpose.

The Organization recognizes donated services that create or enhance nonfinancial assets or that require specialized skills and are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation. A summary of donated facilities, materials and services is as follows:

In addition, many individuals volunteer a substantial amount of time and perform a variety of tasks that assist the Organization with specific assistance programs, campaign solicitations, and administrative duties. These volunteer services representing approximately $46,100 for 2016 and $40,600 for 2015 are not recognized as contributions in the financial statements since the recognition criteria were not met.

Expense Allocation: The costs of providing various programs and other activities have been summarized on a functional basis in the statement of activities and in the statement of functional expenses. Accordingly, certain costs have been allocated among the programs and supporting services benefited.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications: Certain accounts in the prior-year financial statements have been reclassified for comparative purposes to conform with the presentation in the current-year financial statements.

• ACCOUNTS AND PLEDGES RECEIVABLE

Accounts and pledges receivable are unsecured and consist of the following at June 30, 2016 and 2015:

Pledges receivable at June 30, 2016 are expected to be collected within one year.

• PROPERTY AND EQUIPMENT

Property and equipment consist of the following at June 30, 2016 and 2015:

Included in land and buildings is property donated to the Organization by Catholic Charities (CC) during the year ended June 30, 1999. According to CC’s stipulations, at all times the property must be used in connection with the operation of a shelter and/or transitional housing for women and children who are victims of domestic violence, services for victims of domestic violence, or services consistent with the charitable purposes of the Organization. In the event that the Organization ceases to exist as a nonprofit, tax-exempt corporation, title to the property will revert to CC. As of June 30, 2016 and 2015, the Organization was in compliance with this restriction.

• LINE OF CREDIT

The Organization has a $50,000 line of credit with Puget Sound Community Bank with interest payable monthly at an adjustable rate corresponding to the Prime Rate, but not less than 6% (6% at June 30, 2016). The line is secured by real property and matures June 30, 2016. There were no outstanding advances on the line at June 30, 2016.

• NOTE PAYABLE

Note payable consists of a note from Puget Sound Development Commission, payable in monthly installments of $1,328, including interest at 3%, through April 2016; secured by land and building.

• CONTINGENCIES

Amounts received or receivable from various contracting agencies are subject to audit and potential adjustment by the contracting agencies. Any disallowed claims, including amounts already collected, would become a liability of the Organization if so determined in the future. It is management’s belief that no significant amounts received or receivable will be required to be returned in the future.

• RETIREMENT PLAN

Effective September 1, 2005, the Organization adopted a SIMPLE IRA plan that is available to all employees. Participants are eligible for an employer match of their contribution up to 3% of their gross wages. The percentage is established annually by the Board of Directors. The matching percentage established by the Board was 3% in calendar year 2016 and 1% in calendar year 2015. Employees may contribute the maximum amount allowed by IRS regulations. The Organization’s contribution to the Plan totaled $13,927 for the year ended June 30, 2016 and $21,008 for the year ended June 30, 2015.

• BOARD DESIGNATED NET ASSETS

During the year ended June 30, 2005, a board-designated endowment fund was established in the name of Rick Rhoades. The principal of the endowment will be held in perpetuity and income earned will be available for youth programs. Changes in endowment net assets are as follows:

The Organization annually appropriates all income earned of the endowment fund and uses it to support youth programs.

The Organization has adopted an investment policy with the primary objective to preserve the principal value of the assets. The secondary objective is to grow the principal value of the assets. Investment risk is measured in terms of the total endowment fund; investment assets and allocation between asset classes and strategies are managed to not expose the fund to unacceptable levels of risk.

• TEMPORARILY RESTRICTED NET ASSETS

Temporarily restricted net assets at June 30, 2016 and 2015, consist of contributions received restricted for programs.

• SPECIAL EVENTS

Special event revenue is reflected net of contributions and direct costs of donor benefits as follows for the years ended June 30, 2016 and 2015:

Contributions from special events are included with “Contributions” on the statement of activities.

• RELATED PARTY DISCLOSURE

During the year ended June 30, 2016, the Organization purchased electrical services of approximately $24,000 for the construction of the Advocacy Center from a business owned by a board member’s family.

• FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject the Organization to concentrations of credit risk consist primarily of cash balances and pledges and accounts receivable. To limit credit risk, the Organization places its cash and cash equivalents with high credit quality financial institutions. The balances in each financial institution are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. The balances, at times, may exceed the federally insured limit.

The Organization’s pledges and accounts receivable are unsecured and are from individuals, corporations, and governmental institutions located within the same geographic region.

• FAIR VALUE MEASUREMENTS

Assets and liabilities recorded at fair value in the statement of financial position are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Level inputs are defined as follows: Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities. Level 2: Observable inputs other than those included in Level 1, such as quoted market prices for similar assets or liabilities in active markets, or quoted market prices for identical assets or liabilities in inactive markets. Level 3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair values requires significant management judgment or estimation.

At June 30, 2009, assets measured on a recurring basis include certificates of deposit totaling $634,740. Fair value of certificates of deposit is determined using level 2 inputs based on amounts as reported by the financial institutions which hold the funds.

• These computations assume Treehouse's "contracts" are contracts with governments. ↵
• There are several versions of the Ten Point Test. The version presented here is based on the version recommended by Dean Mead, Research Manager at the Governmental Accounting Standards Board. A few of the ratios have been changed slightly to reflect the data available to compute national trends. For the original Mead version see Dean Mead, “A Manageable System of Economic Condition Analysis for Governments,” in Public Financial Management , ed. Howard Frank (Boca Raton, FL: Taylor and Francis, 2006); pp.383-419. ↵
• Note that the near-term liabilities ratio was first presented in Karl Nollenberger (2003), Evaluating Financial Condition: A Handbook for Local Government (Washington, DC: ICMA Press) ↵
• Merritt Research Services collects these data and makes them available through the Bloomberg Terminal. ↵

BUS202: Principles of Finance

Course introduction.

• Time: 63 hours
• College Credit Recommended ($25 Proctor Fee) -->
• Free Certificate

Finance is a broad term; you will find that both managers who compile the financial reports we discussed in financial accounting and stockbrokers working on Wall Street will claim that they "work in finance". So, what exactly is finance? Finance is the management of a company's money and scarce resources. It is distinct from accounting; while accounting aims to organize and compile past information, finance is geared toward deciding what to do with it.

You will be exposed to many different sub-fields within finance in this course. You will learn how to determine which projects have the best potential payoff and how to manage investments and value stocks. All finance boils down to one concept: return. In essence, finance asks: "If I give you money today, how much money will I get back in the future?" Though the answer to this question will vary widely from case to case, you will know how to find the answer by the time you finish this course.

You will learn to use financial concepts such as the time value of money, pro forma financial statements, financial ratio analysis, capital budgeting analysis, capital structure, and the cost of capital. This course will also provide an introduction to bonds and stocks. When you finish this course, you will understand financial statements, cash flow, time value of money, stocks and bonds, capital budgeting, ratio analysis, and long-term financing, and how to apply these concepts and skills to business decisions.

Course Syllabus

First, read the course syllabus. Then, enroll in the course by clicking "Enroll me". Click Unit 1 to read its introduction and learning outcomes. You will then see the learning materials and instructions on how to use them.

Unit 1: Introduction To Finance

Finance is a broad subject, and financial decisions are all around us. Whether you work on Wall Street or in a small company, finance is vital to every business. Therefore, understanding the fundamentals of finance is essential to your business education. In this unit, you will learn about the goal of financial managers, which is to maximize the wealth of shareholders, and why that is important. You will also learn the differences between the types of business organizations that operate in the United States and their advantages and disadvantages. This unit also explains how the financial markets in our country work and the general terminology used throughout the field. Ethical issues that affect the field of finance are also reviewed in this section. Understanding where ethical dilemmas might arise in the workplace is vital for all employees who may be affected by the decisions they, or their management, make.

Completing this unit will take approximately 6 hours.

Unit 2: Financial Statements and Financial Analysis

Unit 3: working capital management.

Working capital management explains how companies manage their day-to-day financial decisions. Effective management of current assets and current liabilities is crucial to make sure companies have enough cash flow to meet their regular obligations and maximize their financial return. The four main focus areas in working capital management are cash, accounts receivable, inventory, and accounts payable. Companies try to find the most effective use of assets and liabilities while balancing the trade-off between liquidity and profitability.

Completing this unit should take you approximately 6 hours.

Unit 4: Time Value Of Money

Suppose you have the option of receiving $100 today or $200 in five years. Which option would you choose? How would you determine which is the better deal? Some of us would rather have less money today vs. wait for more money tomorrow. However, sometimes it pays to wait. Unit 4 introduces the concept of the time value of money and explains how to determine the value of money today versus tomorrow by using finance tools to assess present and future values.

Completing this unit should take you approximately 7 hours.

Unit 5: Stocks, Bonds, and Financial Markets

This unit is designed to help you understand stocks, bonds, and the financial markets they are traded in. You've heard the terms "stocks and bonds" often, but do you really understand the difference? Understanding these important financial instruments can help you professionally and personally as you navigate the choices for your retirement savings accounts and other financial decisions. Stocks and bonds are an important source of capital for businesses to fund new equipment and new projects. For individuals, they present opportunities for their savings to grow over time. Financial markets bring together these investors and corporations so that each can achieve these objectives efficiently and transparently.

Completing this unit should take you approximately 11 hours.

Unit 6: Capital Budgeting Techniques

This unit demonstrates how a financial manager uses financial tools to make capital investment decisions. It addresses the concept of capital budgeting and how to evaluate investment projects using the net present value calculations, internal rate of return criteria, profitability index, and the payback period method. In particular, this unit will teach you how to determine which cash flows are relevant (should be considered) when making an investment decision. For instance, suppose you have been asked to give your recommendation about buying or not buying a new building. As the financial manager, it is your task to identify cash flows that, in some way or another, affect the value of the investment (in this case, the building) and calculate whether the money spent on the project upfront is more or less than the value received. Also, this unit explains how to calculate "incremental" cash flows when evaluating a new project, which can also be considered the difference in future cash flows under two scenarios when a new investment project is being considered.

Unit 7: Risk, Return, and the CAPM

This unit explains the relationship between risk and return. Every investment decision carries a certain amount of risk. Therefore, the role of the financial manager is to understand how to calculate the "riskiness" of an investment versus its reward so that they can make sound financial and business decisions. For example, suppose you are the financial manager for a large corporation, and your boss has asked you to choose between two investment proposals. Investment A is a textile plant in a remote part of a developing country. This plant can generate $50 million in yearly profits. Investment B is a textile plant located in the United States, near a small Virginia town with a rich textile industry tradition. However, investment B's capacity for profits is only $30 million due to higher start-up and operating costs. You are the financial manager. Which option do you choose? While investment A can yield significantly higher profits, there is a great deal of risk that you must consider. Investment B has a much lower profit capacity, but the risk is also lower. This unit explains the relationship between risk and return, and you will learn how to compute the level of risk by calculating expected values and the standard deviation. You will also learn about handling risk in a portfolio with different investments and how to measure a stock investment's expected performance when it is being affected by the overall performance of a stock market.

Unit 8: Corporate Capital Structure

Does it matter whether a company's assets are financed with 50% from a bank loan and 50% from investors' money? Does that form of capital structure, where 50% of assets come from debt and 50% from equity, influence how a company succeeds in business? This unit addresses these questions by focusing on the theory of capital structure. Specifically, this unit explains the concept of capital structure and introduces the most common formula used when comparing a company's return to the cost of capital: the weighted average cost of capital (WACC). We will also explore how tax policy affects a company's true cost of capital.

Completing this unit should take you approximately 5 hours.

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What Is Financial Statement Fraud?

The bottom line.

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Detecting Financial Statement Fraud

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.

On Dec. 2, 2001, energy behemoth Enron shocked the world with its widely-publicized bankruptcy after the firm was busted for committing egregious accounting fraud .   Its dubious tactics were aimed at artificially improving the appearance of the firm's financial outlook by creating off-balance-sheet special purpose vehicles (SPVs) that hid liabilities and inflated earnings. But in late 2000, The Wall Street Journal caught wind of the firm's shady dealings, which ultimately led to the then-largest U.S. bankruptcy in history.   And after the dust settled, a new regulatory infrastructure was created to mitigate future fraudulent dealings.

Key Takeaways

• Financial statement fraud occurs when corporations misrepresent or deceive investors into believing that they are more profitable than they actually are.
• Enron's 2001 bankruptcy in 2001 led to the creation of the Sarbanes-Oxley Act of 2002, which expands reporting requirements for all U.S. public companies.
• Tell-tale signs of accounting fraud include growing revenues without a corresponding growth in cash flows, consistent sales growth while competitors are struggling, and a significant surge in a company's performance within the final reporting period of the fiscal year.
• There are a few methods to inconsistencies, including vertical and horizontal financial statement analysis or by using the total assets as a comparison benchmark.

The Association of Certified Fraud Examiners (ACFE) defines accounting fraud as "deception or misrepresentation that an individual or entity makes knowing that the misrepresentation could result in some unauthorized benefit to the individual or to the entity or some other party." Put simply, financial statement fraud occurs when a company alters the figures on its financial statements to make it appear more profitable than it actually is, which is what happened in the case of Enron.

Financial statement fraud is a deliberate action wherein an individual "cooks the books" to either mislead investors.

According to the ACFE, financial statement fraud is the least common type of fraud in the corporate world, accounting for only 10% of detected cases. But when it does occur, it is the most costly type of crime, resulting in a median loss of $954,000. Compare this to the most common and least costly type of fraud—asset misappropriation, which accounts for 85% of cases and a median loss of only $100,000.   Nearly one-third of all fraud cases were the result of insufficient internal controls.   About half of all the fraud reported in the world were executed in the United States and Canada, with a total of 895 reported cases or 46%.  

The FBI counts corporate fraud, including financial statement fraud, among the major threats that contribute to white-collar crime . The agency states that most cases involve accounting schemes where share prices, financial data, and other valuation methods are manipulated to make a public company appear more profitable.  

Types of Financial Statement Fraud

And then there's the outright fabrication of statements. This, for instance, famously occurred when disgraced investment advisor Bernie Madoff collectively bilked some 4,800 clients out of nearly $65 billion by conducting an elaborate Ponzi scheme that involved wholly falsifying account statements.

Financial statement fraud can take multiple forms, including:

• Overstating revenues by recording future expected sales
• Inflating an asset's net worth by knowingly failing to apply an appropriate depreciation schedule
• Hiding obligations and/or liabilities from a company's balance sheet
• Incorrectly disclosing related-party transactions and structured finance deals

Another type of financial statement fraud involves cookie-jar accounting practices, where firms understate revenues in one accounting period and maintain them as a reserve for future periods with worse performances, in a broader effort to temper the appearance of volatility .

The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 is a federal law that expands reporting requirements for all U.S. public company boards, management, and public accounting firms. The Act, often abbreviated as Sarbanes–Oxley or SOX, was established by Congress to ensure that companies report their financials honestly and to protect investors.

The rules and policies outlined in SOX are enforced by the  Securities and Exchange Commission  (SEC) and broadly focus on the following principal areas:

• Corporate responsibility
• Increased criminal punishment
• Accounting regulation
• New protections

The law is not voluntary., which means that all companies must comply.   Those that don't adhere to the are subject to fines, penalties, and even prosecution.

Financial Statement Fraud Red Flags

Financial statement red flags can signal potentially fraudulent practices. The most common warning signs include:

• Accounting anomalies , such as growing revenues without a corresponding growth in cash flows .
• Consistent sales growth while competitors are struggling.
• A significant surge in a company's performance within the final reporting period of a fiscal year .
• Depreciation methods and estimates of assets' useful life that don't correspond to those of the overall industry.
• Weak internal corporate governance , which increases the likelihood of financial statement fraud occurring unchecked.
• Outsized frequency of complex third-party transactions , many of which do not add tangible value , and can be used to conceal balance sheet debt.
• The sudden replacement of an auditor resulting in missing paperwork.
• A disproportionate amount of management compensation derived from bonuses based on short-term targets, which incentivizes fraud.

Financial Statement Fraud Detection Methods

While spotting red flags is difficult, vertical and horizontal financial statement analysis introduces a straightforward approach to fraud detection. Vertical analysis involves taking every item in the income statement as a percentage of revenue and comparing the year-over-year trends that could be a potential flag cause of concern.

A similar approach can also be applied to the balance sheet, using total assets as the comparison benchmark , to monitor significant deviations from normal activity. Horizontal analysis implements a similar approach, whereby rather than having an account serve as the point of reference, financial information is represented as a percentage of the base years' figures.

Comparative ratio analysis likewise helps analysts and auditors spot accounting irregularities. By analyzing ratios, information regarding day's sales in receivables, leverage multiples, and other vital metrics can be determined and analyzed for inconsistencies.

A mathematical approach known as the Beneish Model evaluates eight ratios to determine the likelihood of earnings manipulation, including asset quality, depreciation, gross margin , and leverage . After combining the variables into the model, an M-score is calculated. A value greater than -2.22 warrants further investigation, while an M-score less than -2.22 suggests that the company is not a manipulator.

Federal authorities have put laws in place that make sure companies report their financials truthfully while protecting the best interests of investors. But while there are protections in place, it also helps that investors know what they need to look out for when reviewing a company's financial statements. Knowing the red flags can help individuals detect unscrupulous accounting practices and stay one step ahead of bad actors attempting to hide losses, launder money, or otherwise defraud unsuspecting investors.

United States Bankruptcy Court Souther District of New York. " Enron Corp. Bankruptcy Information ."

Wall Street Journal. " Energy Traders Cite Gains, But Some Math Is Missing ."

Association of Certified Fraud Examiners. " Report to the Nations: 2020 Global Study on Occupational Fraud and Abuse ," Page 4.

Association of Certified Fraud Examiners. " Report to the Nations: 2020 Global Study on Occupational Fraud and Abuse ," Page 5.

Association of Certified Fraud Examiners. " Report to the Nations: 2020 Global Study on Occupational Fraud and Abuse ," Page 7.

FBI. " White-Collar Crime ."

Reuters. " Madoff Mysteries Remain as He Nears Guilty Plea ."

Soxlaw.com. " The Sarbanes-Oxley Act ."

• Fraud: Definition, Types, and Consequences of Fraudulent Behavior 1 of 31
• What Is White-Collar Crime? Meaning, Types, and Examples 2 of 31
• What Is Corporate Fraud? Definition, Types, and Example 3 of 31
• What Is Accounting Fraud? Definition and Examples 4 of 31
• Financial Statement Manipulation 5 of 31
• Detecting Financial Statement Fraud 6 of 31
• What Is Securities Fraud? Definition, Main Elements, and Examples 7 of 31
• What Is Insider Trading and When Is It Legal? 8 of 31
• What Is a Pyramid Scheme? How Does It Work? 9 of 31
• Ponzi Schemes: Definition, Examples, and Origins 10 of 31
• Ponzi Scheme vs. Pyramid Scheme: What's the Difference? 11 of 31
• What Is Money Laundering? 12 of 31
• How Does a Pump-and-Dump Scam Work? 13 of 31
• Racketeering Definition, State vs. Federal Offenses, and Examples 14 of 31
• Mortgage Fraud: Understanding and Avoiding It 15 of 31
• Wire Fraud Laws: Overview, Definition and Examples 16 of 31
• The Most Common Types of Consumer Fraud 17 of 31
• Who Is Liable for Credit Card Fraud? 18 of 31
• How to Avoid Debit Card Fraud 19 of 31
• The Biggest Stock Scams of Recent Time 20 of 31
• Enron: Scandal and Accounting Fraud 21 of 31
• Bernie Madoff: Who He Was, How His Ponzi Scheme Worked 22 of 31
• 5 Most Publicized Ethics Violations by CEOs 23 of 31
• The Rise and Fall of WorldCom: Story of a Scandal 24 of 31
• Four Scandalous Insider Trading Incidents 25 of 31
• What Is the Securities Exchange Act of 1934? Reach and History 26 of 31
• Securities and Exchange Commission (SEC) Defined, How It Works 27 of 31
• Financial Crimes Enforcement Network (FinCEN) Overview 28 of 31
• Anti-Money Laundering (AML): What It Is, Its History, and How It Works 29 of 31
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Everyday life and its variability influenced human evolution at least as much as rare activities like big-game  hunting

Professor and Chair of Biology at Seattle Pacific University and Affiliate Assistant Professor of Anthropology, University of Washington

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Cara Wall-Scheffler does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Think about taking a walk: where you need to go, how fast you need to move to get there, and whether you need to bring something along to carry the results of your errand.

Are you going on this walk with someone else? Does walking with a friend change your preparation? If you’re walking with a child, do you remember to bring an extra sweater or a snack? You probably did – because people intuitively vary their plan depending on their current needs and situations.

In my research as an anthropologist , I’ve focused on the evolution of human walking and running because I love the flexibility people bring to these behaviors. Humans in all kinds of environments across space and time vary how far they go, when they go and what they go for – whether food, water or friends – based on a multitude of factors, including season, daylight, rituals and family.

Anthropologists split their studies of human activity into two broad categories: what people need to do – including eat, keep their kids alive and so on – and what solutions they come up with to accomplish these needs.

How people keep their children alive is a key issue in my research because it has a direct impact on whether a population survives. It turns out that kids stay alive if they’re with adults. To this end, it is a human universal that women carry heavy loads every day , including kids and their food. This needs-based behavior seems to have been an important part of our evolutionary history and explains quite a few aspects of human physiology and female morphology , such as women’s lower center of mass .

The solutions to other key problems, like specifically which food women will be carrying, vary across time and space. I suggest that these variations are as integral to explaining human biology and culture as the needs themselves.

Impacts of uncommon activities

Evolutionary scientists often focus on how beneficial heritable traits get passed on to offspring when they provide a survival advantage. Eventually a trait can become more common in a population when it provides a useful solution.

For example, researchers have made big claims about how influential persistence hunting via endurance running has been on the way the human body evolved. This theory suggests that taking down prey by running them to exhaustion has led to humans’ own abilities to run long distances – by increasing humans’ ability to sweat, strengthening our head support and making sure our lower limbs are light and elastic.

But persistence hunting occurs in fewer than 2% of the recorded instances of hunting in one major ethnographic database , making it an extremely rare solution to the need to find food. Could such a rare and unusual form of locomotion have had a strong enough impact to select for the suite of adaptive traits that make humans such excellent endurance athletes today?

Maybe persistence hunting is actually a fallback strategy, providing a solution only at key moments when survivorship is on the edge. Or maybe these capabilities are just side effects of the loaded walking done every day . I think a better argument is that the ability to predict how to move between common and uncommon strategies has been the driver of human endurance capacity.

Everyday life’s influence on evolution

Hunting itself, especially of large mammals, is hardly ubiquitous , despite how frequently it is discussed. For example, anthropologists tend to generalize that people who lived in the Arctic even up to a hundred years ago consumed only animal meat hunted by men. But actually, the original ethnographic work reveals a far more nuanced picture .

Women and children were actively involved in hunting, and it was a strongly seasonal activity. Coastal fishing, berry picking and the use of plant materials were all vital to Arctic people’s day-to-day sustenance. Small family groups used canoes for coastal foraging for part of the year.

During other seasons, the whole community participated in hunting large mammals by herding them into dangerous situations where they were more easily killed. Sometimes family groups were together, and sometimes large communities were together. Sometimes women hunted with rifles, and sometimes children ran after caribou.

The dynamic nature of daily life means that the relatively uncommon activity of hunting large terrestrial vertebrates is unlikely to be the main behavior that helps humans solve the key problems of food, water and keeping children alive.

Anthropologist Rebecca Bliege Bird has investigated how predictable food is throughout the day and the year . She’s noted that for most communities, big game is rarely caught, especially when a person is hunting alone. Even among the Hadza in Tanzania, generally considered a big-game hunting community, a hunter acquires 0.03 prey per day on average – essentially 11 animals a year for that person.

Bird and others clearly argue that the planning and flexible coordination done by females is the crucial aspect of how humans survive on a daily basis. It’s the daily efforts of females that allow people to be spontaneous a few times a year to accomplish high-risk activities such as hunting – persistence or otherwise. Therefore it is female flexibility that allows communities to survive between the rare big-game opportunities.

Changing roles and contributions

Some anthropologists argue that in some parts of the world, behavior varies more for cultural reasons , like what tools you make, than for environmental ones, such as how much daylight there is during winter. The importance of culture means that the solutions vary more than the needs.

One of the aspects of culture that varies is the role assigned to specific genders. Varying gender roles are related to the distribution of labor and when people take on certain solution-based tasks . In most cultures, these roles change across a female’s life span. In American culture, this would be like a grandparent going back to college to hone a childhood passion in order to take on a new job to send their grandchildren to college.

In many places, females go from youth when they might carry their siblings and firewood, to early parenthood where they might go hunting with a baby on their back , to older parenthood where they might carry water on their head, a baby on their back and tools in their hands, to postmenopausal periods when they might carry giant loads of mangoes and firewood to and from camp.

Even though always load carrying , our capacity to plan and change our behavior for diverse environments is part of what drives Homo sapiens ’ success, which means that the behavior of females across their different life stages has been a major driver of this capability.

• Anthropology
• Human evolution
• Ethnography
• Women's bodies

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The conundrum of porter hypothesis, pollution haven hypothesis, and pollution halo hypothesis: evidence from the Indian manufacturing sector

• Original Paper
• Published: 16 May 2024

Cite this article

• Prantik Bagchi   ORCID: orcid.org/0000-0002-9056-5835 1 &
• Santosh Kumar Sahu   ORCID: orcid.org/0000-0003-3480-6507 2 , 3  

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In the globalized world, factors, such as environmental regulations and outcomes, are interlinked with foreign direct investment and technological innovation. However, firm-level theories mostly treat them independently. We have filled the gap by carrying out empirical research with an integrated approach at the firm level. The theoretical framework is based on Porter’s hypothesis and the pollution haven hypothesis/pollution halo hypothesis. We collect the data from the center for monitoring Indian Economy Prowess IQ and the Ministry of Environment, Forest, and Climate Change. Using the modified Krugman specialization index, we find that Indian manufacturing firms are neither converging nor specialized in terms of technical progress. Estimating a z -score for environmental stringency, we interact that with the pollution loads of the firms. Our findings suggest that environmental regulation does not ensure a “win–win” situation for the producers, refuting Porter’s hypothesis. Rather, factors such as profit margin and R&D produce robust results across different models to induce the productivity of the firm. One of the concerning facts is older firms using vintage capital are detrimental to productivity enhancement, and there is evidence of layoff at the cost of increasing profits to improve the firm performance. Also, more dependence for export-intensive firms on material increases the cost and, thereby, reduces productivity. In addition, we apply a panel threshold regression model and conclude that there is evidence of a single threshold, and irrespective of the choice of technology foreign firms induces the energy intensity, confirming a pollution Haven hypothesis.

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Environment is considered to be a factor of production.

One of the threat perceptions is that the resource-rich countries are vulnerable to PHH, known as the resource curse hypothesis, although the evidence is mixed (Liang et al. 2023 ).

India imports a large volume of non-renewable resources despite a large volume of production, and this has been increasing over the years (Energy Statistics 2023). A substantial part of it is exported as it does not meet the environmental standard. As there is an excess demand for the same, they import it from the developed countries. A part of this import might be the surplus that does not meet environmental standards in those countries, and the laxity of regulations may induce the threat of both PH and PHH/PHaH.

To the best of our knowledge, this is the first empirical paper to integrate PH and PHH for Indian manufacturing firms.

Since PH incentivizes the firms with a “win–win” situation, the decision of the firm will be taken based on the possibility of the improvement of their outcome. Often this is measured in terms of total factor productivity (TFP).

In this paper, we are not interested in focusing on the narrow version because: i. The interest of the paper does not lie in validating this; and ii. there is an acute shortage of the data.

The list of the indicators will be discussed later. Input intensities refer to labor intensity, capital intensity, material intensity, and energy intensity.

Z = (X it -X t )/σ it.

Intensities are not considered separately to omit the problem of correlation and multicollinearity problems as these variables are used while calculating the TFP.

We have not reported the green firms as it will be considered as base in the regression models.

There is a possibility of the existence of a nonlinearity; specifically, it may have an exponential effect. This may lead to the probabilistic measures to cross their bounds.

As a rule of thumb, we have tested for multicollinearity, stationarity, and cointegration. Since the independent variables have VIFs less than 10, they are found to be non-colinear. Besides, they are stationary in the first difference, and they are found to exhibit a long-term relationship due to the significant cointegration.

We have calculated the mean spending on R&D by domestic and foreign firms. It is seen that foreign firms are spending four to five times more on R&D than domestic firms.

We have tested the correlation of the dependent variable and the covariates. It exhibits that tax and profit are highly correlated (0.49), and hence, we keep both of them in separate regression and compare them. This was carried out for the unbalanced panel as well, but in that case, the correlation was less than 0.3.

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Acknowledgement

The paper is presented in the SHADG 2024 Conference, CoE-SEA, IIT Kharagpur. The authors are highly benefitted with the valueable comments and suggestions received by the reviewers and the editor of the paper.

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Department of Humanities and Social Sciences, Indian Institute of Technology Kharagpur, Kharagpur, West Bengal, 721302, India

Prantik Bagchi

Department of Humanities and Social Sciences, Indian Institute of Technology Madras, Chennai, Tamil Nadu, 600036, India

Santosh Kumar Sahu

School of Sustainability, Indian Institute of Technology Madras, Chennai, Tamil Nadu, 600036, India

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Bagchi, P., Sahu, S.K. The conundrum of porter hypothesis, pollution haven hypothesis, and pollution halo hypothesis: evidence from the Indian manufacturing sector. Clean Techn Environ Policy (2024). https://doi.org/10.1007/s10098-024-02886-z

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Received : 14 January 2024

Accepted : 06 May 2024

Published : 16 May 2024

DOI : https://doi.org/10.1007/s10098-024-02886-z

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