The importance of a composite score
Introduced as an amendment to the Higher Education Act of 1965, a composite score is a tool used to measure the relative financial health of an educational institution.
What is a Composite Score?
A composite score is a number that categorizes institutions between the range of -1.0 and 3.0. It is a combined score of three separate financial ratios:
- Primary reserve
- Equity
- Net income ratios
Why is a Composite Score Important?
Because of numerous multi-campus closings over the past several years as a result of financial instability, in addition to the unemployment rate directly affecting enrollment and retention, the Department of Education found it valuable to measure institutions’ financial well-being. It is therefore important to note that this score measures financial health, and it does not indicate educational quality of an institution.
The Three Ratios
Not-for-profit and for-profit schools’ composition scores are calculated similarly; however, a few key differences exist. While each ratio is weighted when combined, not-for-profit schools weigh the primary reserve and equity ratios at 40 percent and the net income ratio at 20 percent. For-profit schools weigh the primary reserve and net income ratios at 30 percent and the equity ratio at 40 percent.
Primary Reserve Ratio
The primary reserve ratio represents a measure of a school’s viability and liquidity. It can be improved by paying back distributions or draws prior to year-end, maintaining a line of credit with a maturity of over a year, reviewing your composition score quarterly, reviewing your tax structure to retain as much equity as possible, and more.
Equity Ratio
The equity ratio represents a measure of a school’s capital resources and its ability to borrow. An institution can increase this score by paying short-term liabilities at year-end, selling fixed assets, and more.
Net Income Ratio & How to Improve a Composite Score
The net income ratios is described as representing a measure of a school’s profitability. By increasing enrollment to generate increased tuition and auxiliary revenue, delaying expenditures that would affect net income, and considering adjusting compensation prior to year-end to ensure better results, an institution can improve its score.
Calculating the Composite Score
The net income ratio is weighted higher for a for-profit institution than for a not-for-profit entity, as for-profits have a greater focus on income statements. In contrast, not-for-profit institutions have a focus on balance sheets, meaning their primary reserve ratio is weighted higher than for a for-profit. The equity ratio carries the same weighted percentage for both types of institutions. Still, solid strength factors in one area can compensate for an institution’s weaker factors.
Each strength factor is multiplied by the “weighting factor” to arrive at the three calculated ratios. Strength factors are maxed out at 3.0 and then multiplied by the weighting factor, and composite scores cannot be higher than a 3.0. Thus, the three ratios are added together to obtain a composite score.
How to Interpret Composite Score Results
A school is considered financially responsible if it receives a score of 1.5 to 3.0. Entities with a score of 1.0 to 1.4 are deemed “in the zone,” which means they can face increased oversight by the Department of Education. In addition, a school can only be classified as in the zone for three consecutive years. A score of -1.0 to 0.9 signifies that a school is not financially responsible, and it must obtain a 1.0 in one of the next three years.
Further Takeaways
Ratios are based on year-end amounts, so improving the balance sheet at year-end is really the key to a successful composite score. It is important to note that many schools have debt covenant ratios to maintain as well. If an entity is having an unusually strong financial year, it may consider writing off additional accounts receivable and incurring expenditures sooner than planned.
In addition to the composite score, the Department of Education evaluates an institution’s financial responsibility by assessing whether a school has sufficient funds to make timely refunds to students and the department, is meeting other financial obligations, and is current on its debt obligations. Schools are encouraged to invest in capital and technology to improve the student’s experience on campus long-term.
For further assistance understanding your school’s composite score, please contact our team of experts.
