Sample Financial Due Diligence For A Merger 2z51k

SAMPLE FINANCIAL SUMMARY FOR TWO NONPROFIT ORGANIZATIONS CONSIDERING A MERGER This is an excerpt of a merger analysis that Mission + Strategy was asked to do for two clients, which included a financial component. The financial analysis was completed by XXXX, an associate of Mission Plus Strategy consulting. One of the nonprofits involved had a budget of $15M and the other nonprofit had a budget of $600,000. The scope of work involved analyzing the most recently completed audited statements for both nonprofits, the current financial statements and the current budgets. This was not financial due diligence. ________________________________________________

In conducting this financial analysis, we focused on three key questions that we believe are integral in assessing this merger: 1. What is the overall financial condition of each organization? 2. From where does each organization derive its revenue, and does their donor base overlap? 3. What are the potential positive and negative implications of the merger from a financial standpoint? Summary of key findings: 1. Based on our analysis, we believe DEF Nonprofit is in a stronger financial position than the ABC Nonprofit, due to their cash reserves and overall liquidity. However, we also acknowledge that both organizations realized a decrease in net assets in the three years we reviewed (with the exception of DEF Nonprofit in 2009), which is a cause of concern that should be reviewed in greater detail. 2. Both organizations rely on private donations in order to fund part of program and general operating expenses. In reviewing the donor list for each organization, there are only two donors in common: The Chicago Community Trust and the Polk Bros. Foundation. The combining revenue across both organizations from these donors is $421,000, which is approximately 26% of the combined private contribution revenue. If this giving level did not stay consistent to the merged organization, it would cause a financial strain to already underfunded organizations. 3. We also believe there is an opportunity for cost savings through consolidation of istrative and back office operations. We have identified various expense items where cost savings are typically realized, however further analysis would be required to determine the true cost savings of a merger based on staff and istrative structure.

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A. Financial Overview Below are three tables which represent a financial summary of both organizations. The revenue and expenses include all funding and expenses, including grant revenue that es directly through program services. Gross revenue for DEF Nonprofit decreased from 2008 – 2009, then dramatically increased in 2010 due to a $7.8 million increase in the Homeless Prevention Rapid Re-Housing Program (HPRP) grant revenue. The ABC Nonprofit realized an increase in gross revenue from 20082009 due to increased Grant and Contribution revenue, but then decreased in 2010. Total assets for DEF Nonprofit have grown consistently from 2008-2010, while ABC Nonprofit’s assets have decreased in each of the three years.

DEF Nonprofit 2008-2010 Financial Summary 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 2008

2009 Revenue

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Expenses

Assets

2010 Liabilities

ABC Nonprofit 2008-2010 Financial Summary 1,200,000 1,000,000 800,000 600,000 400,000 200,000 2008 Revenue

2009 Expenses

Assets

2010 Liabilities

B. Financial Analysis The financial strength of each organization can be measured in various ways. For this analysis, we have chosen to focus on the liquidity of each organization based on their respective balance sheets, using the following ratios: (1) Current Ratio – This ratio will measure each organization’s ability to cover current liabilities with current assets. (2) Cash Ratio – This ratio will measure each organization’s ability to cover current liabilities with just cash on hand. This is similar to the current ratio, but a more conservative test. (3) Months Spending in Reserve – We look at this to determine how much reserves each organization has in order to absorb any fluctuations in cash flow. For this analysis, we have removed the “Public Sources” category of expenses from DEF Nonprofit, as this is directly related to Public Revenue.

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DEF Nonprofit 2008 Current Ratio Cash Ratio Months Spending in Reserve

2009

ABC Nonprofit

2010

2008

2009

2010

1.37

9.73

11.51

1.67

2.15

N/A

1.24

3.10

9.28

0.99

0.91

N/A

0.99

4.52

2.98

(1.38)

(0.54)

0.59

Both organizations have sufficient current assets to cover current liabilities. However, DEF Nonprofit historically has had a greater multiple of cash on hand to cover liabilities. The ABC Nonprofit did not have enough cash to cover current liabilities in 2008 or 2009. Although In 2010, the ABC Nonprofit does not have any liabilities and therefore we feel this is a positive improvement to their overall financial position. When it comes to the Months Spending in Reserve, the ABC Nonprofit does not have adequate Unrestricted Net Assets in reserves to deal with an interruption in revenue. On the contrary, DEF Nonprofit has averaged 1-3 months of Unrestricted Net Assets in reserve. This is a positive sign that the organization would be able to continue should there be a delay in collecting revenue1. A positive sign for both organizations is that neither carries any current loans on their balance sheet. DEF Nonprofit maintains an open line of credit for $350,000, which is approximately 1.75 months of operating expenses. The ABC Nonprofit carries an open line of credit of $65,000, which represents approximately 1.5 months of operating expenses.

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In the non-profit sector, one-to-three months of spending in reserve is generally accepted, with one month being adequate, and three months being healthy.

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C. Revenue/Expense Analysis Since both organizations raise private dollars which fund both general and istrative expenses, along with program expenses, it is helpful to examine what percentage of nongovernmental revenue is available for program expenses, and how much is needed for general operating expenses.

DEF Nonprofit 2008

2009

ABC Nonprofit 2010

2008

2009

NonGovernmental Revenue $1,860,012 $1,965,696 $1,907,051 $401,236 $923,997 Management, General & Fundraising (MGF) Expenses $406,864 $514,075 $572,632 $77,046 $82,394 MGF Expenses as a % of NonGovernmental Revenue 22% 26% 30% 19% 9% Percentage Remaining for Program Services 78% 74% 70% 81% 91% MGF Expenses as a Percentage of Total Revenue 8.90% 10.37% 5.89% 14.23% 8.49%

2010

$451,202

$63,105

14%

86%

12.30%

Based on this analysis, it would appear that the ABC Nonprofit is able to distribute a greater percentage of its private revenue directly into program services. However, we recognize that as the dollar amount of private contributions increase, the overhead required to maintain those contributions also increases. Additionally, DEF Nonprofit has received significantly higher public grant funds in 2010 that directly through program services, which could also increase the overhead required to maintain that process. It should also be noted that DEF Nonprofit invested heavily in technology and fund development in 2010, which caused a greater percentage of the private contribution dollars to be absorbed through overhead. The percentage of management, general and fundraising expenses against total revenue is also presented in the table. Although DEF Nonprofit shows a lower percentage in 2010, this is mainly due to the additional through grant revenue that was received, and does not necessarily reflect a decrease in those expenses. 5|Page

With the ABC Nonprofit realizing roughly 25 percent the amount of private contributions of DEF Nonprofit, it is reasonable to estimate that a combined organization would not have an overhead amount greater than what DEF Nonprofit currently realizes. D. Potential Efficiencies from a Merger With the merger of these organizations, there are various expense categories that we believe would be reduced due to a duplication of expenses in both organizations. While these are general observations, a detailed due diligence process would further determine the best structure to determine how much cost savings could truly be realized. Expense Item

DEF Nonprofit 2010 Expense

ABC Nonprofit 2010

Combined Expenses

Salaries & Wages Occupancy Expenses Utilities & Telecommunications Computer Expenses

$722,934 $51,377

$330,040 $25,359

$1,052,974 $76,736

$14,637 $7,667

$6,765 $3,800

$21,402 $11,467

In the salaries and wages category, although program staff expense is usually not reduced through a merger, we usually see the most savings in the istrative and back office positions. The other three categories of expenses can be reduced mainly though office space and operational consolidation. When two physical offices are combined, the expenses such as computer and telecommunications are typically reduced. Since both organizations seem to deploy a high percentage of private dollars to management and general expenses, we believe there is a significant amount of cost savings potential in these areas. Conservatively, we would anticipate at least an eight to ten percent savings through consolidation.

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